In a 2006 decision, the Pennsylvania Commonwealth Court agreed with Reed Smith's arguments, and rejected the Department of Revenue’s policy—reaffirming the principle that the numerator of an apportionment factor must reflect only in-state activity. The Department appealed this decision by filing exceptions to an en banc panel of the court. In an opinion issued Friday, the court, in a 4-to-3 decision, again agreed with Reed Smith's arguments. FedEx Ground Package System, Inc. v. Commonwealth of Pennsylvania, decided April 17, 2006, exceptions denied April 27, 2007.

The issue in FedEx Ground was the interpretation of Pennsylvania’s revenue-miles fraction, which is the apportionment fraction used to apportion the income and value of transportation companies for purposes of Pennsylvania’s corporate net income and franchise taxes.

Since 1971, the Department of Revenue has used average receipts per mile everywhere in the numerator of the fraction. The court, however, rejected this approach and held that the numerator must be computed using average receipts per mile in Pennsylvania. The court explained that the numerator of an apportionment fraction must reflect only in-state activity, and the Department’s approach would have included everywhere activity (average receipts per mile everywhere) in the numerator.

Significance of the Decisions

Although the case involved a transportation company, the court’s decisions have broader implications. The court reaffirmed the principle that only in-state activity belongs in the numerator. Other states have adopted throwout and throwback rules to assign a larger share of sales to their state, which may violate such a principle. At least Pennsylvania courts have recognized that only in-state activity should increase a taxpayer’s apportionment proportion.

In finding for the taxpayer, the court gave no weight to what the Department of Revenue called its “well settled practice” concerning the revenue-miles fraction. Even though the Department’s approach had been its practice since 1971, this practice received no deference from the court. Rather, the plain language of the statute controlled. So taxpayers should continue to fight unwritten “policy” positions that would increase their tax. Despite objections from the dissent, the majority of the court did not set aside the principle that for Pennsylvania purposes, apportionment statutes must be strictly construed against the government. Therefore, if your company has an appeal involving the application of Pennsylvania’s apportionment provisions, this rule of strict construction may be a significant advantage.