Philadelphia’s position is that if a business is not an essential business as defined in the orders of the mayor and governor and if it does not occupy its premises, that it is not occupying its premises which then should be reported as vacant on a U&O filing.
While this seems straight forward, there are ambiguities. These ambiguities are magnified by the procedural aspects of this tax. While the tax is levied on tenants, landlords collect the tax and file tax reports. If the landlord fails to collect a tax that Philadelphia successfully proves to be due, then the landlord is liable for that tax unless the landlord notified the city in writing that it sought to collect the tax and the tenant refused to pay the tax. The city notice implementing the COVID-19 provisions requires the landlord filing to indicate vacant space, which is space that the tenant could not occupy due to the governmental orders and which it did not in fact occupy. In other words, the procedure set forth by the Department of Revenue puts landlords at risk.
Some businesses may be easy. Retail clothing stores have to close, unless they sell apparel for essential service providers. The governor’s order classifies accounting firms as essential. In the city’s view accounting firms must pay U&O even if they close their offices and work remotely to protect their staff because they could not implement social distancing in their offices.
Restaurants must close to the extent that they provide dining services. However, the governor’s order lists them as essential businesses but they are only permitted to offer take-out and delivery. They are considered by the city to use their premises even if the kitchen is only a small portion of the premises. Going one step further, if restaurants are an essential business, do they have to pay U&O even if they do not implement delivery and take out? In the city’s view are they similar to the accounting firms or can a restaurant avoid U&O by completely closing? How can the city legally distinguish these situations?
Law firms are major tenants of Philadelphia office buildings. Law firms generally are not regarded as essential businesses. Many service businesses are allowed to have a skeleton crew of support persons to open and route mail, check on equipment, perhaps perform copying and delivery, etc. even though no lawyers are in the office. In addition, they may have a computer network in the office that needs to be maintained. Philadelphia has taken the position that a law firm with a skeleton copy room crew and computer support staff is occupying its entire office even if not one lawyer, paralegal or administrative assistant is working from the office due to the government orders. But the world is not that simple. During the last decade or so many law firms have hired companies, some independent, some related, to run their back offices. Many firms also maintain computer systems off-site or in the cloud. Would Philadelphia take the position that a law firm occupies space when it has no employees on the premises, but another business is using a portion of its space to render services to the law firm? If the back office’s company is occupying 1% of the firm’s space, U&O should only be paid on 1% of the space, right?
To recap law firms, you can have two law firms that operationally appear identical, but one uses employees for backroom services and another uses a third party, and potentially the city will come to a different conclusion on whether leased space is being used by the law firm. Or if one firm set up its servers remotely or migrated to the cloud, it will have a different result than a firm that retained servers in its Philadelphia office. But even after you resolve the use issue, you have to come back to the essential business issue. While law firms are not essential businesses, the governor’s order defers to president judges or similar federal judges who can designate a matter as essential. If that happens, the governor’s order allows lawyers to work from their office. If the business is essential, the city apparently deems it occupied even if the firm requires all lawyers to work remotely to protect the health of all its personnel. In the city’s view, is space only occupied during the pendency of such a judicial determination or is no lawyer’s space eligible for U&O vacancy because theoretically any member of the Pennsylvania bar could be a participant in an essential action? If a law firm has 200 lawyers in Philadelphia, is all of its space occupied during the closure period if one lawyer is involved in an essential case for a few days? Is all space taxable even if no case handled by that firm is essential during the entire period of the close-down?
These dilemmas can also apply to other professions or businesses. For example, most medical providers are essential. But many providers have closed their offices to protect patients and staff and are only practicing telemedicine. While they are essential, they are also subject to social distancing rules and feel that remote work is the best way to comply with all directives.
Given all this uncertainty, return to the landlord’s dilemma. Does a landlord simply report no space as vacant because of COVID-19 orders and leave it for the tenant and city to sort out? Does a landlord taking this position violate a duty to the tenant? The city placed reporting burdens on the landlord but its failure to allow a landlord to rely on an exemption certificate is a major shortcoming in the procedures.
This alert discusses the city’s view of who should be paying U&O tax. But at the end of the day the city must act in a lawful manner. We understand that the city considers itself as adversely impacted by this disaster as almost any business. The city needs to maintain police and fire protection, as well as fund its schools and the rest of the city government. But, does that give the Department of Revenue the right to classify accounting firms that decide to close to protect employees as being subject to U&O, while classifying small restaurants, that also are listed as essential businesses, as not being subject to U&O if they do not implement take-out and delivery? We normally do not rely on tax authorities to tell us law. They publish their position which the tax community evaluates and decides to follow or challenge. But, given the strains and challenges of COVID-19, it would be refreshing to see a coherent policy that most of us could agree was legal and proper. Until that happens, please get in touch should you wish to discuss your unique facts and circumstances.
As the last word, perhaps the city is hoping that lawyers, accountants and other service providers in similar circumstances will pay U&O out of a sense of civic duty, not compare themselves to bankrupt restaurants and not hold the city’s feet to the fire. If that is it, perhaps the mayor should be holding a zoom town hall to make his case.
The Coronavirus Task Force at Klehr Harrison stands ready to assist you in your business and legal needs. We will continue to provide additional information and guidance as the COVID-19 situation develops.
Author Larry Arem is a partner in the tax practice group at Klehr Harrison.