State and Local Tax Topics

Proposed Sugar Tax Leaves Sour Taste In Many Mouths

by Stewart Weintraub and Jennifer Weidler

Friday, May 28th, 2010

As a result of the devastating impact the recession has had upon state and local tax revenues, state and local taxing authorities (“Taxing Authorities”) are scrambling to fill budget deficits with revenue generated from whatever source they can find.  Using a campaign against the spread of obesity throughout the United States as its basis, the solution some Taxing Authorities are opting to propose are new taxes aimed at what some argue is a cause of the epidemic: so-called “sugar-sweetened” beverages, including sodas, juices, juice drinks, flavored milks, flavored teas and sports drinks.  Seventeen states, plus the District of Columbia, proposed some form of sugar-sweetened beverage tax during 2009 and 2010.  Most proposals failed, in large part due to growing opposition from various groups.

The City of Philadelphia is the latest Taxing Authority to consider the implementation of such a beverage tax.  However, at its May 20, 2010, meeting, Philadelphia’s City Council declined to vote upon the proposal and passed the fiscal 2011 budget without its consideration.  The proposal would have imposed an unprecedented tax of $.02 per ounce upon pre-packaged sugar sweetened beverages and a tax of $.18 per ounce of syrup used for sales of sugar-sweetened fountain drinks.  Although it appears to be dead for the coming fiscal year, Philadelphia’s Sugar-Sweetened Beverage Tax (“Beverage Tax”) proposal highlighted some of the issues raised by the potential implementation of such a tax.

While most of the legal issues raised by the Beverage Tax proposed by Philadelphia would be relevant to a Beverage Tax imposed by any Taxing Authority, at least one of the legal issues of concern to a locally imposed Beverage Tax would not be of concern to a state imposed Beverage Tax.  The unique local Beverage Tax issue is derived from the principle that local governments possess no inherent power to tax.  All power to tax at the local level must be directly traceable to some legislative authority granting local governments the power to impose the tax.  Philadelphia’s proposed Beverage Tax presents a classic example of these principles.   Issues common to all Taxing Authorities are state and federal constitutional issues.  Does the Beverage Tax withstand constitutional scrutiny pursuant to the Equal Protection clause of the Untied States Constitution and pursuant to the Uniformity clause of the state’s constitution?  Furthermore, policy issues compound these potential legal issues.

First, Philadelphia derives its power to tax from a 1932 Act of the Pennsylvania General Assembly, known as the Sterling Act.  The Sterling Act grants Philadelphia the power to impose privilege taxes, like the Beverage Tax.  However, the Sterling Act withdraws that power, inter alia, if the City is taxing something Pennsylvania is already taxing.  For example, soda, a sugar sweetened beverage, is subject to the Pennsylvania Sales Tax.  It is argued that since the Beverage Tax is essentially a consumption tax upon consumers, it is tantamount to a Sales Tax, which is preempted by the Sterling Act.

The First Class City Business Tax Reform Act is another state Act authorizing imposition of a local tax, the Philadelphia’s Business Privilege Tax (“BPT”).  When enacted, the BPT Act included a provision that prohibited Philadelphia from imposing the BPT if it imposed another tax based upon or measured by gross receipts, for the privilege of doing business in Philadelphia.  Thus, it is argued that imposition of the Beverage Tax triggers the BPT Act preclusion from imposing another business privilege tax while the BPT remains imposed.

The final legal argument against the Philadelphia Beverage Tax is whether it passes constitutional scrutiny pursuant to the Uniformity Clause of the Pennsylvania Constitution and the Equal Protection Clause of the United States Constitution, both of which require the uniformity/equality of taxation, unless there is a reasonable basis for treating one class of taxpayers differently from another.  The rational basis advanced by proponents of the Beverage Tax is to deter the purchase of so-called “sugar sweetened beverages”, the deterrence of such purchases they claim promotes healthy eating habits and fights obesity.  However, those opposing the Beverage Tax offer two counterarguments to the proffered rationale.  First, if fighting obesity is the reasonable basis for treating such beverages differently, what is the reasonable basis for not including other sugar-sweetened food products, such as candy, ice cream, and donuts?  Opponents observe that such foods contain higher concentrations of sugar than beverages like soda and juice drinks.  After all, according to the National Cancer Institute, soft drinks, sports drinks, sweetened water beverages and energy drinks combined account for only 5.5% of calories in the U.S. diet, which means 94.5% of calories come from other foods and beverages.  Secondly, if the reasonable basis is truly fighting obesity, opponents question why only a small portion of the revenue (for the proposed Philadelphia Beverage Tax approximately 30% of the estimated revenue) to be derived from the Beverage Tax is being dedicated to programs fighting obesity, with the remainder (approximately 70% of the revenue) merely being added to Philadelphia’s General Fund.  Further, up until this year, the only two states  — West Virginia and Arkansas – that have taxes that single out soft drinks, which were passed decades before obesity was an issue –also have among the highest rates of obesity in the nation (they are the 3rd and 10th most obese states in the nation, according to Centers for Disease Control and Prevention).  The question that remains to be answered is whether the Beverage Tax is really a tax for general revenue purposes being disguised as a tax intended to fight obesity.

Apart from these legal issues, the Beverage Tax proposal also presents policy issues.  Opponents of the Beverage Tax argue that it is bad tax policy, which would have a deleterious effect upon small businesses and jobs within those small businesses.  If the Beverage Tax is a cost of doing business for the retailer (not a tax upon the consumer for the purchase of the sugar sweetened beverage), the magnitude of the Beverage Tax precludes a store owner from passing the cost of the Beverage Tax through to the purchasers of the sugar sweetened beverage.  Instead, the cost will be added to the cost of all products sold by the store owner not just the sugar sweetened beverages.  As a result, the Beverage Tax would not deter the purchaser of the sugar sweetened beverage from purchasing the product.  Alternatively, the store owner must instead incur the Beverage Tax as an additional cost, which to maintain profitability, would cause the store owner reduce other expenses, possibly through layoffs.

While the goal seems to be combating obesity while raising revenues, one must truly question whether such tax policy can accomplish that objective.  Ultimately, apart from legal questions relating to such proposals, one must question whether the tax is even good policy or whether it will instead be more detrimental than constructive.

Now that Philadelphia’s effort to impose a Beverage Tax appears to be at an end for the coming fiscal year, the “cameras” turn to other jurisdictions, which are likewise considering enactment of a beverage tax.  For instance, in the District of Columbia, a member of its City Council recently introduced a proposal for the imposition of a $.01 per ounce excise tax upon sugar sweetened beverages to help finance a Healthy Schools Initiative.  Due to lack of support, within the past few days the Bill’s sponsor withdrew it.  Instead, the District of Columbia amended its 6% sales tax to make soft drinks subject thereto.  Additionally, Washington and Colorado imposed beverage taxes, but on the basis of restoring state budget gaps.  During February, Colorado eliminated the 2.9% state sales tax exemption for sugary beverages, among myriad of other taxes, and during April Washington state imposed a beverage tax of $.02 per ounce of carbonated beverage.  Meanwhile, while New York’s governor, David Paterson, continually advocates for a beverage tax, the New York Senate and Assembly did not add a beverage tax to its list of budget proposals.  Of the seventeen states to consider beverage tax proposals, the vast majority have declined to adopt them.

IN RE: ACE AMERICAN INSURANCE COMPANY, INC.: A CHALLENGE TO PHILADELPHIA’S TREATMENT OF NONQUALIFIED DEFERRED COMPENSATION

by Stewart Weintraub

In general, Pennsylvania does not follow the Internal Revenue Code for Pennsylvania Personal Income Tax (“PIT”) purposes. During the late 1990s, the Pennsylvania Department of Revenue (“Department”) reversed its long standing position and diverged from federal income tax rules, becoming the only state to determine that elective nonqualified deferred compensation was taxable during the year it was earned, not when it was actually received. During 2005, the Pennsylvania legislature amended the PIT statute, thereby reversing the Department’s position. In addition to overruling the Department’s policy, the PIT amendment statutorily reversed a highly publicized Commonwealth Court decision holding that contributions to a nonqualified deferred compensation plan were subject to PIT at the time of deferral and not subject to PIT at the time of distribution. Contrary to the case law and the Department’s policy, the PIT amendment provided that contributions to nonqualified deferred compensation plans were subject to PIT at the time of distribution not at the time of deferral, thus conforming Pennsylvania’s PIT treatment of nonqualified deferred compensation to the federal standard.

However, different rules may apply for purposes of Philadelphia taxation. Currently, the City of Philadelphia is asserting the position that nonqualified deferred compensation is subject to Philadelphia Wage Tax at the date of deferral, not at the date of distribution – thus contrary to the PIT and federal law. The City of Philadelphia imposes a wage upon “salaries, wages, commissions and other compensation due,” which it further defines as, “[w]ages, commissions, bonuses, incentive payments, fees and tips that may accrue or be received…for services rendered.” Philadelphia Code, §19-1501(10). The City imposes the wage tax upon City residents, regardless of their place of employment, as well as non-City residents to the extent they work within the City.

In the case of In Re: Ace American Insurance Company, Inc., Docket No. 36WMMERZZ9625, Ace sought to challenge the validity of Philadelphia’s determination that non qualified deferred compensation was subject to wage tax at the time of deferral not the time of distribution. The Tax Review Board ruled against Ace, holding that contributions to nonqualified plans are subject to wage tax at the time of deferral. The Court of Common Pleas affirmed the decision of the Tax Review Board and the case is currently pending on appeal before the Commonwealth Court.

All businesses with nonqualified deferred compensation plans should be concerned with the outcome of Ace. Depending upon how a business has treated the withholding of Philadelphia wage tax from nonqualified deferred compensation plans will dictate how the decision will affect the particular employer. If the court ultimately holds that wage tax should have been withheld at the time nonqualified deferred compensation was earned, businesses which withheld wage tax at the time of distribution from nonqualified deferred compensation plans are subject to audit and assessment by the City. However, if the courts ultimately hold that wage tax should have been withheld at the time the nonqualified deferred compensation was distributed, businesses which withheld wage tax at the time of contributions to nonqualified deferred compensation plans would have a basis to file refund claims for the wage tax improperly withheld and remitted. Thus, it is important that employers and employees alike who are subject to the Philadelphia wage tax keep a watchful eye on the outcome of this case before the Commonwealth Court.

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