Pennsylvania's Manufacturing Exemption

By Hopkins, Peter Desmond M. | The CPA Journal, June 2000 | Go to article overview
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Pennsylvania's Manufacturing Exemption


Hopkins, Peter Desmond M., The CPA Journal


THE COMMERCE CLAUSE generally prohibits any tax that gives preference to one state over another.

Most corporations doing business or incorporated in Pennsylvania dare subject to an annual tax known as the capital stock franchise (CSF) tax. This tax is based on the average book net income over the most recent five years and the book value of the company. For corporations with multistate operations, an apportionment percentage is applied to the tax base to determine the amount taxable in Pennsylvania. The apportionment percentage is typically calculated using a standard three-factor formula: property, payroll, and sales. Since the early part of the 20th century, a manufacturing exemption has resulted in a significantly lower tax for Pennsylvania manufacturers.

For many years, the manufacturing exemption permitted corporations to exclude amounts related to manufacturing from the numerator of the apportionment percentage. Thus, a corporation could exclude property and payroll attributable to manufacturing as well as sales that resulted from manufacturing activities. Property and payroll that served both manufacturing and nonmanufacturing functions were split into that which was attributable to the manufacturing function and that which was not. The exemption produced numerators that represented nonmanufacturing property, payroll, and sales within Pennsylvania.

The exemption was intended to apply only to manufacturing activities within Pennsylvania. At first glance, this point would seem to be minor, because property, payroll, and sales outside the state are not included in the numerators. However, when applied to corporations operating in multiple states that had headquarters or administrative offices in Pennsylvania, the matter became significant. The property and payroll used in the management of the business had to be allocated between what was attributable to Pennsylvania manufacturing activities and what was not.

Thus, a Pennsylvania management office that directed the activities of two identical manufacturing plants, one outside Pennsylvania, could exclude only half of its property and payroll from the numerator. Closing an out-of state plant would allow such a company to exclude all of the managment office's property and payroll, while opening a third plant outside Pennsylvania would reduce the exemption.

Constitutional Challenge

The Commerce Clause of the U.S. Constitution generally prohibits any tax that gives preference to one state over another. Clearly, the manufacturing exemption gave preference to Pennsylvania manufacturers over those in other states in a discriminatory way, because the act of hiring a single employee in an out-of state manufacturing plant could result in an increase in the CSF tax. Yet the exemption survived until June 1999, when the Pennsylvania Supreme Court finally declared it unconstitutional in PPG Industries, Inc.

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