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As a result of some judicial scrambling, the Philadelphia Eagles scored a significant victory over the city of Philadelphia in a contest concerning the application of the city’s Business Privilege Tax. In Philadelphia Eagles Football Club Inc. v. Philadelphia, PA, (No. 14 EAP, 2001, April 25), the Pennsylvania Supreme Court ruled that the Eagles’ share of revenues derived from the National Football League’s television network contracts constitutes copyright royalties subject to Philadelphia’s Business Privilege Tax, but only to the extent of 50 percent of such revenues, on the rationale that only one-half of the team’s games are played in Philadelphia. Beginning in 1985, the city implemented the Business Privilege Tax pursuant to the authority granted to the city under the First Class City Business Tax Reform Act of 1984 (53 P.S. §§ 16183, 16184). The BPT is imposed upon the gross receipts and net income of “every person engaging in any business in the city of Philadelphia” (Philadelphia Code § 19-2603(1)). For purposes of the BPT, a “person” is defined to include “any individual, partnership, limited partnership, association, corporation, estate or trust.” The BPT is composed of two separate components, a tax calculated based upon the taxpayer’s gross receipts and a tax calculated based upon the taxpayer’s net income. Only the gross receipts component of the BPT was involved in the Eagles case. The tax controversy arose as a result of an audit by the city of the BPT returns filed by the Eagles for the tax years 1986 through 1994. As a result of that audit, the city made an assessment against the Eagles, asserting that 100 percent of the team’s television revenues should have been subject to the gross receipts component of the BPT. The Eagles filed a review petition with the Philadelphia tax review board and argued that only 50 percent of the television revenues should have been subject to the BPT calculations because only eight of the Eagles’ 16 regular season football games were played in and broadcast from Philadelphia. The board determined that the television revenues constituted fees for services rendered (i.e., fees for the playing of football games), and because the Eagles played only one-half of their football games in Philadelphia and the balance of their games in other cities, only one-half of the team’s television revenues were subject to the BPT as fees for services rendered in Philadelphia. Under the Philadelphia Code, receipts for services rendered outside the city are excluded from the BPT (Philadelphia Code (§ 19-2601). Appeals from the board’s decision were filed with the Court of Common Pleas of Philadelphia County by both the Eagles and the city. The Court of Common Pleas reversed in part and affirmed in part the decision of the board. Specifically, the court reversed the board’s conclusion that the team’s television revenues were fees for services rendered and found, as a matter of law, that those revenues were copyright royalties resulting from the licensing of a property right. The court further concluded that 100 percent of those copyright royalties were subject to the BPT. In reaching this decision, the court relied upon § 322 of the BPT regulations promulgated by the city. This regulation, governing taxation of royalties, provides as follows: “[W]here a taxpayer … retains its commercial domicile in Philadelphia, all patent, copyright and trademark royalties received are to be included in the measure of tax unless attributable to business conducted at a place of business regularly maintained by the taxpayer outside of Philadelphia.” Both the Eagles and the city appealed the decision of the court of common pleas to the Commonwealth Court. A five-member panel of the Commonwealth Court unanimously affirmed the order of the common pleas court and held that 100 percent of the team’s television revenues were subject to the gross receipts component of the BPT. The Eagles subsequently filed an appeal to the Supreme Court of Pennsylvania. The two issues addressed by the supreme court were whether the Commonwealth Court erred in concluding that the television revenues were copyright royalties subject to the BPT and whether the Commonwealth Court erred in holding that the city was not required to apportion the television revenues in assessing the BPT in order to comply with the Commerce Clause of the U.S. Constitution (U.S.C.A. Const. Art. 1, § 8, cl.3). The majority opinion written by Justice Russell M. Nigro contains a lengthy but cogent analysis of the nature of the television revenues received by the Eagles and concludes that the television revenues constitute copyright royalties received from the licensing of a property right; namely, the exclusive right to broadcast NFL football games. This portion of the court’s holding is firmly supported by extensive case law, general principles of intellectual property and the terms of the network contracts with the NFL that entitled the Eagles to their proportionate share of such revenues. The court next moved on to the more controversial aspect of the case by addressing whether any apportionment of the television revenues was appropriate. The Eagles argued that the Commerce Clause requires that all income, regardless of the characterization of that income as royalties or fees for services, must be apportioned to reflect the underlying activity that generated the income. The Eagles further argued that as a result of this constitutional requirement, only half of the television revenues, which corresponded to the percentage of the Eagles’ games that were played in and broadcast from Philadelphia, should have been subject to the BPT. The court agreed with the Eagles’ argument in favor of apportionment. The court cited the holdings of several U.S. Supreme Court decisions that in order to pass constitutional muster, a state or local tax must be both “internally consistent” and “externally consistent.” To satisfy the internal consistency test, the court stated that a tax must be structured so that if every taxing jurisdiction were to apply the identical tax, the taxpayer would not be subject to a risk of double taxation. The court concluded that the city’s proposed application of the BPT to the television revenues satisfied the internal consistency test because if every NFL city were to impose such a tax on television revenues, then each jurisdiction would only be able to tax the royalties of those teams commercially domiciled within its boundaries. If such were the case, since the Eagles were domiciled in Philadelphia, no other jurisdiction would have authority to tax their television revenues and no double taxation could result. However, on the application of the “external consistency” test, the court appears to have fumbled the ball with a favorable bounce to the Eagles. Again, reciting decisions of the U.S. Supreme Court, the court stated that the external consistency requirement is a subjective test that measures whether a state taxes only that portion of the revenues from the interstate activity which reasonably reflects the intrastate component of the activity being taxed. The court further explained that the external consistency test “looks to the economic justification for the state’s claim upon the value being taxed in order to discover whether the state is taxing economic activity that occurred in other jurisdictions.” According to the court, a tax will fail the external consistency test if it can be demonstrated by “clear and cogent evidence” that the income attributed to the state either is out of all appropriate proportion to the business transacted by the taxpayer in that state, has led to a grossly distorted result for the taxpayer or is inherently arbitrary. Applying the foregoing standards to the city’s application of the BPT, the court concluded that taxing 100 percent of the Eagles’ television revenues when half of the team’s games were telecast from NFL venues outside of Philadelphia “was inherently arbitrary and had no rational relationship to the football club’s business activity that occurred in Philadelphia.” The court further noted that by taxing the team’s activities in other jurisdictions, the city put the Eagles at risk of being subjected to multiple taxation. In reaching the opposite conclusion, the Commonwealth Court had relied upon the clear language of § 322 of the BPT regulations and what it considered to be established precedent that for tax purposes, the situs of intangible personal property was at the domicile of the owner of such property and that the royalties earned on such property must be allocated entirely to the domicile of the taxpayer. Alternatively, the Commonwealth Court concluded that the city was entitled to tax 100 percent of the television revenues because the economic activities that gave rise to the creation of the intellectual property took place in Philadelphia. In rejecting these conclusions, Nigro argued that the Commonwealth Court did not properly recognize that half of the Eagles’ football games were played outside of Philadelphia and, therefore, improperly concluded that the economic activity that generated the television revenues had exclusively taken place in Philadelphia. There are several perplexing aspects of the court’s decision. First is the suggestion by the court, unsupported by any facts, that the television revenues received by the Eagles which were attributable to games played outside of Philadelphia would be taxed by the cities in which the games were actually played. There was no evidence submitted to the court that any NFL city was attempting to tax the television revenues earned by visiting teams. In fact, such an attempt by an NFL city to tax the television revenue of a visiting team would likely fail. It’s well established that in addition to the requirement of fair apportionment, a tax will be sustained against a Commerce Clause challenge only if it is applied to an activity with a substantial nexus to the taxing jurisdiction and it fairly relates to the benefits provided by the taxing jurisdiction. It is highly questionable whether a gross receipts tax imposed by an NFL city on any portion of the television revenues earned by a visiting team would satisfy these Commerce Clause requirements. Moreover, as Justice Ronald D. Castille noted in his dissent, the requirement of every NFL city to tax a portion of the television revenues of each game played in that city inevitably would results in disputes and litigation over the imposition of such tax and would lead to an uneven application of the tax laws. Also, allocating royalties from the licensing of intellectual property to where the “economic activity” of the licensed property takes place does not appear logical. This method of allocation would appear more appropriate for the allocation of revenues earned for services rendered (which the court correctly concluded was not what the Eagles’ television revenues represented). Even if the court’s method of allocation is correct, no consideration was given to pre-season or post-season games or to where the Eagles conduct their practices or maintain their corporate offices. Under the rationale of the court, the Eagles could have been domiciled in any jurisdiction and still be liable for the BPT for that portion of the television revenues attributable to the eight games played in Philadelphia. Although the Eagles’ season came to a disappointing halt on the field, the team enjoyed a significant victory in the Supreme Court of Pennsylvania. By allowing the team to exclude one-half of its television revenues from the calculation of the BPT, it is likely that the other half of the team’s revenues will completely escape taxation by any other municipality. Moreover, the court’s decision invalidates § 322 of the BPT regulations. Accordingly, the ruling in the Eagles case could have a substantial impact on a variety of taxpayers domiciled in Philadelphia who receive significant royalty income. Mark L. Silow is chairman of the tax and estates department at Fox Rothschild O’Brien & Frankel and serves on the firm’s executive committee. Silow’s work involves a broad range of commercial and tax matters including business and tax planning, corporate acquisitions and dispositions, real estate transactions, estate planning and employee benefits.

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