IN THE COMMONWEALTH COURT OF PENNSYLVANIA
Nextel Communications of the :
Mid-Atlantic, Inc., :
Petitioner :
:
v. : No. 98 F.R. 2012
: Argued: September 16, 2015
Commonwealth of Pennsylvania, :
Respondent :
BEFORE: HONORABLE DAN PELLEGRINI, President Judge
HONORABLE BERNARD L. McGINLEY, Judge
HONORABLE BONNIE BRIGANCE LEADBETTER, Judge
HONORABLE RENÉE COHN JUBELIRER, Judge
HONORABLE MARY HANNAH LEAVITT, Judge
HONORABLE P. KEVIN BROBSON, Judge
HONORABLE ANNE E. COVEY, Judge
OPINION BY JUDGE BROBSON FILED: November 23, 2015
In this appeal from the Board of Finance and Revenue (Board),
Petitioner Nextel Communications of the Mid-Atlantic, Inc. (Nextel) challenges
the Board’s denial of its petition for refund of corporate net income (CNI) tax paid
to the Commonwealth of Pennsylvania for the tax year ending December 31, 2007
(2007 Tax Year). In pursuing its refund, Nextel contends that the net loss
carryover deduction (NLC deduction) provision in Section 401(3)4.(c)(1)(A)(II) of
the Tax Reform Code of 1971 (Tax Reform Code),1 as applied to Nextel,2 violates
1
Act of March 4, 1971, P.L. 6, as amended, 72 P.S. § 7401(3)4.(c)(1)(A)(II).
2
Nextel does not here press a facial constitutional challenge to the corporate net income
tax or to the NLC deduction.
the uniformity requirement (Article VIII, Section 1) of the Pennsylvania
Constitution (Uniformity Clause). For the reasons set forth below, we find in favor
of Nextel, reverse the Board’s Order, and grant relief to Nextel.
The NLC deduction provision of the Tax Reform Code allows a
taxpayer to reduce its positive taxable income in a particular tax year by deducting
prior year net losses (i.e., where the taxpayer had negative taxable income in a
prior year), thereby reducing the amount of CNI tax due and payable in that tax
year. Net losses from prior tax years may be carried over to subsequent tax years
and applied to reduce taxable income according to a schedule set forth in
Section 401(3)4.(c)(2) of the Tax Reform Code, 72 P.S. § 7401(3)4.(c)(2). For
example, a net loss in taxable years 1995 through 1997 may be carried over for ten
taxable years. A net loss in taxable years 1998 and thereafter may be carried over
for twenty taxable years. In addition to limiting how long a taxpayer may carry
over its net losses, the Tax Reform Code also limits the amount of the NLC
deduction that a taxpayer may take in any given tax year. For the 2007 Tax Year,
the amount of the NLC deduction was limited to the greater of 12.5% of the
taxpayer’s taxable income or $3 million. Section 401(3)4.(c)(1)(A)(II) of the Tax
Reform Code.
Nextel is a telecommunications company that does business in
multiple states, including Pennsylvania. Our inquiry is confined to Nextel’s
income and losses relating to its Pennsylvania business. According to the parties’
Stipulation of Facts, Nextel carried over net losses of $150 million into the 2007
2
Tax Year.3 Nextel earned $45 million of taxable income during the 2007 Tax
Year. Accordingly, Nextel’s available net loss carryover in 2007 well exceeded its
2007 taxable income. Consistent with the NLC deduction provision of the Tax
Reform Code that limits the amount of the NLC deduction that a taxpayer may
take in the 2007 Tax Year, Nextel reported for the 2007 Tax Year its full
$45 million in taxable income to the Commonwealth, but it took only a
$5.6 million NLC deduction (the greater of 12.5% of its taxable income or
$3 million). As a result, Nextel reduced its taxable income for the 2007 Tax Year
to $39.4 million and paid CNI tax of $4 million on that amount.4
Nextel filed a timely petition for refund of CNI tax paid in the 2007
Tax Year, in which it argued, inter alia, that the NLC deduction cap of the greater
of 12.5% of taxable income or $3 million was unconstitutional. The Department of
Revenue Board of Appeals (Revenue) and the Board held that they lacked the
authority to consider and rule on Nextel’s constitutional challenge. They both
concluded that Nextel properly applied the NLC deduction provision as written
when it filed its tax report and paid its taxes for the 2007 Tax Year. Accordingly,
Revenue denied Nextel’s request for a refund, and the Board affirmed.
The Uniformity Clause provides: “All taxes shall be uniform, upon
the same class of subjects, within the territorial limits of the authority levying the
tax . . . .” Nextel contends that the limitations on the NLC deduction favor
businesses with taxable income of $3 million or less. Assuming these taxpayers
3
The figures set forth herein are rounded in the interest of presentation. The actual
figures are set forth in the parties’ Stipulation of Facts.
4
The statutory CNI tax annual rate is 9.99%. Section 402(b) of the Tax Reform Code, as
amended, 72 P.S. § 7402(b).
3
have a net loss carryover in excess of their taxable income in a particular year—
i.e., a positive net loss carryover position—these taxpayers can reduce their taxable
income to $0. By contrast, any taxpayer that has taxable income in excess of
$3 million in a tax year, who is also in a positive net loss carryover position, is
precluded from reducing its taxable income to $0. That taxpayer will always have
to pay CNI tax, even if its net loss carryover exceeds its taxable income that year.
According to Nextel and the parties’ Stipulation of Facts,5 this
actually occurred in 2007. In the 2007 Tax Year, 19,537 taxpayers subject to the
CNI tax were in a positive net loss carryover position—i.e., the amount of their net
loss carryovers exceeded the amount of taxable income apportioned to
Pennsylvania for the 2007 Tax Year. Of those 19,537 taxpayers, 19,303 (98.8%)
were able to completely offset their taxable income through the NLC deduction
provision. These particular taxpayers had taxable income at or below $3 million.
Because the 2007 Tax Year NLC deduction was limited to the greater of 12.5% of
taxable income or $3 million, these taxpayers, using the $3 million cap, were able
to avoid paying any CNI tax for the 2007 Tax Year.
The other 1.2%, or 234 taxpayers, in a positive net loss carryover
position in the 2007 Tax Year, paid some CNI tax that tax year. They had taxable
income in excess of $3 million. Indeed, the majority of the 234 taxpayers had
taxable income in excess of $6 million. Because of the limitations placed on the
NLC deduction that year, these taxpayers could not reduce their taxable income to
$0. A taxpayer in a positive net loss carryover position in 2007 with $3,000,001 in
taxable income in the 2007 Tax Year would have paid $0.10 in CNI tax. But a
5
Stipulation of Facts Ex. D.
4
similarly-situated taxpayer in the 2007 Tax Year with one dollar less in taxable
income would have owed no CNI tax under the NLC deduction provision. For
taxpayers with substantially more taxable income in the 2007 Tax Year, the tax
consequences were more severe. Nextel was among twenty-six taxpayers whose
taxable income in 2007 exceeded $24 million. At most, these taxpayers could only
reduce their taxable income by 12.5% under the NLC deduction limitations.
Nextel maintains that this disparate treatment of taxpayers, based
solely on the size of the business in terms of taxable income in the 2007 Tax Year,
violates the Uniformity Clause. In Nextel’s view, the NLC deduction limitations
work in favor of small taxpayers in a positive net loss carryover position and
against similarly-situated larger taxpayers. The larger the taxpayer (i.e., the greater
the income), the more disparate the impact. Accordingly, Nextel argues that the
NLC deduction limitations create an unconstitutional progressive CNI tax
structure, where small taxpayers pay a lower effective tax rate than larger,
similarly-situated, taxpayers, even though the statutory rate is fixed at 9.99%.6
In response, the Commonwealth contends that there is no Uniformity
Clause violation, because the same statutory rate of 9.99% is applied to the same
base in every case (taxable income less NLC deduction). Similarly, because the
same statutory rate is applied against the same tax base for every taxpayer, the
Commonwealth argues that we must reject Nextel’s characterization of the CNI tax
as unconstitutionally progressive. The Commonwealth also argues that we must
reject Nextel’s contention that the Uniformity Clause demands that all taxpayers
6
The Pennsylvania Business Council has filed an Amicus Brief in favor of Nextel’s
appeal.
5
pay the same effective tax rate, because Pennsylvania courts have consistently
rejected such uniformity challenges to the CNI tax.
The Commonwealth disputes Nextel’s contention that larger taxpayers
were somehow penalized in the 2007 Tax Year. In terms of effective tax rate, the
Commonwealth notes that Nextel paid an effective CNI tax rate of 8.75%, less than
the statutory rate. The Commonwealth also compares Nextel to a smaller taxpayer
that was not in a positive net loss carryover position in 2007 and, therefore, may
have paid a higher effective tax rate than Nextel did. Also, the Commonwealth
emphasizes that even though Nextel’s NLC deduction was limited to 12.5%, it was
still able to reduce its taxable income by $5.6 million, which is well in excess of
the $3 million cap. According to the Commonwealth: “The smaller businesses
that are the focus of Nextel’s argument never would have been able to take such a
large net loss deduction.” (Commonwealth Br. at 21.)7
The Commonwealth contends that even if you accept Nextel’s
position that the NLC deduction cap creates some form of classification, the NLC
deduction limitations satisfy the constitutional test of “rough” uniformity. The
Commonwealth notes that the cap only affected 1.2% of CNI taxpayers in the 2007
Tax Year. The 1.2%, however, like the other 98.8%, were still able to take a net
loss deduction of 12.5% of taxable income or $3 million, whichever was greater,
and still paid the statutory rate of 9.99%. So while they may have been negatively
impacted, in the sense that they had to pay CNI tax, the disparity does not itself
7
We agree with the Commonwealth on this point, because, at most, those smaller
corporations, which reported taxable income in the 2007 Tax Year of $3,000,000 or less, can
only reduce their taxable income to $0.
6
demonstrate unconstitutionality. The outcome, in the Commonwealth’s view, is
“nearly perfect” and thus satisfies the constitutional test of rough uniformity.
(Commonwealth Br. at 27.)
The Commonwealth also argues that even if the NLC deduction
limitations create classifications among taxpayers, the classification is reasonable
in that it is rationally related to the legitimate state interest of sensible budgetary
planning. The Commonwealth recounts the thirty-year history of the NLC
deduction. Throughout this period, the Commonwealth contends that the General
Assembly has struggled to balance the pro-growth benefits of the deduction with
its negative impact on the Commonwealth’s budget. This struggle, the
Commonwealth maintains, led the General Assembly to enact legislation in 1991
that suspended the NLC deduction for tax years beginning in 1991. See Garofolo,
Curtiss, Lambert & MacLean, Inc. v. Dep’t of Rev., 648 A.2d 1329 (Pa. Cmwlth.)
(holding that legislation suspending NLC deduction did not violate Uniformity
Clause), appeal dismissed, 659 A.2d 561 (Pa. 1994). The Commonwealth notes
that when the General Assembly reinstated the NLC deduction, it determined that
the Commonwealth’s budget could only handle a limited NLC deduction. For the
2007 Tax Year, the General Assembly set the limit at the higher of 12.5% of
taxable income or $3 million. Although the General Assembly has increased the
limitations over time,8 it has not seen fit to remove the limitations. Because the
General Assembly concluded that the Commonwealth could not afford an
8
For tax years beginning after December 31, 2014, the NLC deduction is capped at the
greater of 30% of taxable income or $5 million. Section 401(3)4.(c)(1)(A)(VI) of the Tax
Reform Code, as amended, 72 P.S. § 7401(3)4.(c)(1)(A)(VI).
7
unlimited NLC deduction, the Commonwealth’s position is that Nextel’s desire for
an unlimited deduction must give way to the General Assembly’s wisdom with
respect to sensible budgetary planning.
The Commonwealth also rejects Nextel’s argument that the General
Assembly lacks the authority to enact legislation that benefits small business.
Indeed, the Commonwealth contends that the NLC deduction was intended to help
small business. The favorable treatment afforded to small business by the NLC
provision was an exercise of the General Assembly’s wide discretion in matters of
taxation. The Commonwealth also points out that not all businesses benefitted
from the NLC provision. Of the 46,676 taxpayers that reported positive taxable
income apportioned to Pennsylvania during the 2007 Tax Year, less than half
availed themselves of the NLC deduction. The Commonwealth also contends that
Nextel’s business model, which led to many unprofitable years, prevented Nextel
from recouping fully its net loss deduction.
Finally, the Commonwealth argues that although the NLC deduction
limitations prevented Nextel from fully offsetting its taxable income in the 2007
Tax Year by its net loss carryovers from prior years, the law permits carryover of
net losses for twenty years. Any assertion by Nextel that its inability to offset its
taxable income in 2007 fully by its net operating losses means that Nextel will
forever lose the benefit of the NLC deduction is unfounded and speculative.
In reply, Nextel emphasizes its base premise—i.e., that under the NLC
deduction provision, a taxpayer with a net loss carryover from Year 1 of $3 million
and income of $3 million in Year 2 will pay $0 in CNI tax in Year 2, but a
taxpayer with a net loss carryover from Year 1 of $30 million and income of
$30 million in Year 2 will pay $2.6 million in CNI tax for Year 2. Because Nextel
8
contends that Pennsylvania law prohibits tax classifications based on the size of
business (as measured by income), the NLC deduction limitations violate the
Uniformity Clause. With respect to its effective tax rate argument, Nextel
concedes the Commonwealth’s point that taxpayers may pay different effective
rates based on the nature of their operations and their deductions. Nonetheless,
different effective rates cannot be based on a deduction statute that has disparate
impact on taxpayers solely on the basis of their income level and withstand a
uniformity challenge.9 Here, the effective tax rate rises not solely because of each
company’s peculiar net loss and income position in a tax year, but also because the
statutory scheme imposes a capped deduction that favors those taxpayers with
taxable income of $3 million or less.
Nextel also disputes the Commonwealth’s “rough” uniformity claim.
Nextel argues that “rough” uniformity is not dependent on the number of taxpayers
adversely affected, but the degree in difference between the amount of tax paid
between taxpayers. Here, Nextel paid $3.9 million of tax while others that, like
Nextel were in a positive net loss carryover position, paid $0. According to
Nextel, that is not “rough” uniformity.
9
To illustrate Nextel’s point, consider a NLC deduction that has no cap. Company A
enters Tax Year 2 with a net loss carryover of $1 million and reports taxable income in Tax Year
2 of $3 million. After deducting in full the net loss carryover, Company A pays a CNI tax of
$199,800 (9.99% x $2 million), for an effective tax rate on $3 million of income in Year 2 of
6.66%. Company B entered Tax Year 2 with a net loss carryover of $10 million and reports
taxable income in Tax Year 2 of $50 million. After deducting in full the net loss carryover,
Company B pays a CNI tax of $3,996,000 (9.99% x $40 million), for an effective tax rate on
$50 million of income in Year 2 of 7.99%. Although Company B pays a higher effective tax rate
under this example, Nextel’s position is that the Uniformity Clause is not implicated because the
effective rate was not influenced by a classification scheme in the tax law based on taxpayer
income; rather, it is the result of the peculiar business operations of each company.
9
In terms of the legislative history, Nextel does not dispute the General
Assembly’s authority to eliminate the NLC deduction, as it did in 1991. If it
allows the deduction, however, the General Assembly cannot limit the amount of
the deduction based on taxpayer income. Nextel also argues that the General
Assembly’s policy reasons for establishing the NLC deduction limitations are
irrelevant. Even if the General Assembly’s reasoning was sound and the limits
reasonable, the scheme must still be uniform. Moreover, to the extent the
Commonwealth’s position is that the General Assembly purposefully favored small
business over large business when it instituted the NLC deduction limitations, the
argument further supports Nextel’s uniformity challenge. Nextel notes that if the
people of Pennsylvania wished to impose a greater tax burden on large businesses
and provide relief to small businesses, they can amend the Constitution, as they
have done in other contexts.10
10
Nextel cites Article VIII, § 2(b)(ii) of the Pennsylvania Constitution, which, following
the section that includes the Uniformity Clause, provides:
(b) The General Assembly may, by law:
...
(ii) Establish as a class or classes of subjects of taxation
the property or privileges of persons who, because of age,
disability, infirmity or poverty are determined to be in need of
tax exemption or of special tax provisions, and for any such
class or classes, uniform standards and qualifications. The
Commonwealth, or any other taxing authority, may adopt or
employ such class or classes and standards and qualifications,
and except as herein provided may impose taxes, grant
exemptions, or make special tax provisions in accordance
therewith. . . .
(Emphasis added.)
10
In terms of whether Nextel has been disadvantaged, seeing as it may
carry over net operating losses for a 20-year period, Nextel notes that under the
statute, the 20 years is a rolling period, running from each year in which Nextel
incurred a net operating loss. For example, a net operating loss incurred in 1998
can only be used to offset taxable income until 2018. If unused by that time, it is
lost, or, as Nextel claims, expired. According to the deposition testimony of
Terrence D. Frederick, who works for Nextel’s parent company, Sprint, and
oversees state and local tax obligations for the parent and its subsidiaries, millions
of dollars in net operating loss carryovers that could have been applied to reduce
Nextel’s taxable income in the 2007 Tax Year but for the statutory cap, have, in
fact, expired.11
A taxpayer challenging the constitutionality of tax legislation bears a
heavy burden. Leonard v. Thornburgh, 489 A.2d 1349, 1351 (Pa. 1985). First, the
taxpayer must demonstrate that the provision results in some form of classification.
Second, the taxpayer must demonstrate that the classification is “unreasonable and
not rationally related to any legitimate state purpose.” Clifton v. Allegheny Cnty.,
969 A.2d 1197, 1211 (Pa. 2009); see Lebanon Valley Farmers Bank v.
Commonwealth, 83 A.3d 107, 113 (Pa. 2013). The legislature, however, has wide
discretion in matters of taxation. Leonard, 489 A.2d at 1351. It is well-established
that tax legislation is presumed to be constitutionally valid and will not be declared
unconstitutional unless it “clearly, palpably and plainly violates the constitution.”
Free Speech, LLC v. City of Phila., 884 A.2d 966, 971 (Pa. Cmwlth. 2005).
11
Stipulation of Facts, Ex. H (Frederick Dep. Tr. at 41:6-41:19).
11
Furthermore, “[a]ny doubts regarding the constitutionality of tax legislation should
be resolved in favor of upholding its constitutionality.” Id.
Although the Uniformity Clause does not require absolute equality
and perfect uniformity in taxation, the legislature cannot treat similarly-situated
taxpayers differently. Leonard, 489 A.2d at 1352. Where the validity of a tax
classification is challenged, “the test is whether the classification is based upon
some legitimate distinction between the classes that provides a non-arbitrary and
‘reasonable and just’ basis for the difference in treatment.” Id. (quoting Aldine
Apartments, Inc., v. Commonwealth, 426 A.2d 1118 (Pa. 1981)). In other words,
“[w]hen there exists no legitimate distinction between the classes, and, thus, the tax
scheme imposes substantially unequal tax burdens upon persons otherwise
similarly situated, the tax is unconstitutional.” Id.
The Commonwealth contends that because the CNI statutory tax rate
is the same for all taxpayers (9.99%), there can be no Uniformity Clause violation.
This position does not comport with the law. Even where a tax law provides for a
fixed statutory tax rate applicable to all taxpayers, the tax scheme may still yield
unconstitutionally divergent tax burdens. The Pennsylvania Supreme Court has
held: “While reasonable and practical classifications in tax legislation are
justifiable and often permissible, when a method or formula for computing a tax
will, in its operation or effect, produce arbitrary, unjust, or unreasonably
discriminatory results, the uniformity requirement is violated.” Clifton, 969 A.2d
at 1211 (emphasis added). We must, therefore, consider whether the NLC
deduction, in operation or effect for the 2007 Tax Year, which is part of the
method or formula for computing the CNI tax, violated the Uniformity Clause.
12
Based on our review of the parties’ Stipulation of Facts, Nextel has
demonstrated that the NLC deduction provision in the Tax Reform Code creates
classes of taxpayers according to their taxable income. As written, the NLC
deduction provision can, and in the 2007 Tax Year did, allow some taxpayers to
reduce their taxable income to $0 and, as a result, pay no CNI tax. The same
provision can, and in the 2007 Tax Year did, prevent other taxpayers from
reducing their taxable income to $0 and, as a result, cause these affected taxpayers
to pay at least some CNI tax. Both classes of taxpayers entered the 2007 Tax Year
in a positive net operating loss carryover position—i.e., their net operating loss
carryover exceeded their 2007 taxable income. The only factor that distinguishes
between these two classes of taxpayers (those who paid no CNI tax as a result of
the NLC deduction provision and those that paid some CNI tax as a result of the
NLC deduction provision) is the amount of taxable income in the 2007 Tax Year.
Taxpayers with $3 million or less in taxable income in 2007 could offset up to
100% of their taxable income through the NLC deduction provision, because the
statute allows a greater of 12.5% of taxable income or $3 million deduction.
Taxpayers with more than $3 million in taxable income in 2007, however, under
this scheme, could not offset up to 100% of their taxable income. In fact, the
higher the taxable income of the taxpayer, the lower the percentage of taxable
income the taxpayer could offset through the NLC deduction. Eventually, the
amount of taxable income that may be offset bottoms out at the 12.5% statutory
rate.12
12
Based on the limitation in effect for the 2007 Tax Year, for taxpayers with taxable
income of $24 million or less, the maximum NLC deduction was the statutory cap of $3 million.
(Footnote continued on next page…)
13
Having concluded that the NLC deduction provision of the Tax
Reform Code for the 2007 Tax Year treated taxpayers with taxable income in
excess of $3 million differently than taxpayers with $3 million or less in taxable
income, we must now determine whether this classification is unreasonable and not
rationally related to any legitimate state purpose. On this question, we agree with
Nextel that a classification based solely on income amount cannot withstand
scrutiny under the Uniformity Clause. In In re Cope’s Estate, 43 A. 79 (Pa. 1899),
the Pennsylvania Supreme Court considered a uniformity challenge to the
Commonwealth’s inheritance tax law,13 which then exempted $5,000 worth of
property from the tax calculation for all estates. Big or small, then, every estate
could exclude $5,000 of assets from the calculation of the tax.
Referring generally to the scope and limitations of the General
Assembly’s power to tax under the Uniformity Clause, the Supreme Court opined
that “[a] pretended classification, that is based solely on a difference in quantity of
precisely the same kind of property, is necessarily unjust, arbitrary, and illegal.”
Id. at 81. The Court continued:
These limitations on the power of the legislature mean
something. They are plainly intended to secure, as far as
possible, uniformity and relative equality of taxation, by
(continued…)
For taxpayers with taxable income in excess of $24 million, the statutory rate of 12.5% of
taxable income yielded the greater net loss carryover deduction.
13
At the time of Cope’s Estate, the Uniformity Clause was set forth in Article IX,
Section 1 of the Pennsylvania Constitution. That section also vested in the General Assembly
the power to exempt certain property from taxation. Cope’s Estate, 43 A. at 81. In
Pennsylvania’s current Constitution, the General Assembly’s authority to exempt certain
property from taxation (Art. VIII, § 2) is set forth separately from the Uniformity Clause.
14
prohibiting, generally, the exemption of a certain part of
any recognized class of property, and subjecting the
residue to a tax that should be borne uniformly by the
entire class, and by guarding against any other device
that necessarily or intentionally infringes on the
established rule of uniformity and relative equality
which, as we have seen, underlie every just system of
taxation.
Id. With this in mind, the Supreme Court held that the inheritance tax scheme
violated this constitutional mandate of uniformity and relative equality:
In any view that can reasonably be taken of these
limitations [in the Uniformity Clause], it must be
manifest, to any reflecting mind, that the act in question
offends against them by undertaking to wholly exempt
from taxation the personal property of a very large
percentage of decedents’ estates, and impose increased
and unequal burdens on the residue of the same class of
property. If the authority to exempt, etc., which was
assumed and exercised by the legislature in this case, is
sanctioned by this court, the constitutional rule of
uniformity virtually becomes a dead letter, and, in lieu of
the will of the people plainly declared in the fundamental
law of the state, the unrestrained will of the legislature
becomes supreme law on that subject. If the legislature
had authority, under the constitution, to do what was
done in this case, they had like authority to reverse their
order of taxation, etc., and thus impose the tax on
personal property amounting in value to $5,000 and less,
and exempt therefrom all property of same recognized
class in excess of that sum; and, consequently, they have
like authority, in every case, to establish any other
arbitrary ratio, between the amount in value of property
to be taxed and that which shall be exempt therefrom, in
any class of subjects.
Id. (emphasis added).
15
The Supreme Court then returned to its earlier premise, which
undergirded its entire reasoning: “The money value of any given kind of property
. . . can never be made a legal basis of subdivision or classification for the purpose
of imposing unequal burdens on either of such classes, or wholly exempting either
of them from any burden.” Id. at 82 (emphasis added). The Supreme Court
estimated that approximately 90-95% of estates annually paid no inheritance tax as
a result of the $5,000 exemption cap, leaving only 5 to 10% of estates subject to
the 2% tax. Cope’s Estate, 43 A. at 82. In this Supreme Court’s words, this
disparity “illustrates the injustice and inequality that must result from such special
legislation.” Id.
Cope’s Estate has stood the test of time, perhaps because of its simple
adherence to a straightforward reading of the Uniformity Clause. To the extent the
General Assembly exercises its power to tax property, it cannot set a valuation
threshold that, in effect, exempts some property owners from the tax entirely.
The Commonwealth offers no reasoned or persuasive argument to eschew this
precedent in this case. Here, the General Assembly has elected to tax property—
i.e., corporate net income. It has also allowed taxpayers to deduct from their
taxable income carryover net losses from prior years. By capping that deduction at
the greater of $3 million or 12.5% of taxable income, however, the General
Assembly has favored taxpayers whose property (i.e., taxable income) is valued at
$3 million or less. To the extent these taxpayers are in a positive net loss carryover
position, they pay no corporate net income tax—i.e., they have no tax burden.
A similarly-situated taxpayer with more than $3 million in taxable income,
however, cannot avoid paying tax under the NLC deduction provision. The
distinction is based solely on asset value, which is, under Cope’s Estate, “unjust,
16
arbitrary, and illegal.” Id. at 81.14 Moreover, the fact that the NLC deduction
provision enabled 98.8% of taxpayers in a positive net loss carryover position to
avoid paying any tax in 2007, leaving 1.2% of similarly-situated taxpayers to pay
some tax, “illustrates the injustice and inequality that must result from such special
legislation.” Id. at 82.
We must also reject the Commonwealth’s claim that the General
Assembly had sound budgetary reasons for imposing the NLC deduction
limitations. We do not question the General Assembly’s ability to impose
limitations on the NLC deduction, so long as those limitations do not impose
unequal tax burdens on the taxpayers or exempt one class from paying the tax
entirely. “[R]egardless of the extent to which the political branches are responsible
for budgetary matters, they are not permitted to enact budget-related legislation
that violates the constitutional rights of Pennsylvania citizens.” Hosp. &
Healthsystem Ass’n of Pa. v. Commonwealth, 77 A.3d 587, 598 (Pa. 2013). For
the reasons set forth above, the limitations in the NLC deduction provision,
particularly the operation and effect of the $3 million alternative cap, violate the
Uniformity Clause.
Finally, that Nextel and other high-income taxpayers may, in future
years, be able to apply unused net losses to reduce taxable income does not change
the fact that some taxpayers paid no tax in Tax Year 2007 because of the NLC
14
The arbitrariness of the $3 million limitation is evident in light of Cope’s Estate.
The Commonwealth argues that the General Assembly imposed the $3 million limitation in an
effort to benefit “small business.” If true, then the General Assembly can define “small
business” in a fashion unrestrained by the text of the Uniformity Clause. The Supreme Court
expressly rejected such unbridled legislative power in Cope’s Estate.
17
deduction provision, while Nextel and others did. A taxpayer should not have to
wait twenty years to get the same deduction that another taxpayer, because of a
legislatively-imposed cap based solely on the value of the property to be taxed, can
take in Year 1.
This brings us to the question of remedy. The Commonwealth
contends that if we hold the NLC deduction provision unconstitutional, we should
strike the NLC deduction provision in its entirety. We disagree. We do not have
before us a facial challenge to the NLC deduction provision and have not analyzed
Nextel’s claim under that rubric. See Johnson v. Allegheny Intermediate Unit,
59 A.3d 10, 16 (Pa. Cmwlth. 2012) (en banc). Instead, Nextel claims that the NLC
deduction provision is unconstitutional as applied to Nextel for the 2007 Tax Year.
Having resolved that limited question in Nextel’s favor, any relief afforded in this
case should be confined to remedying that alleged wrong.
“[A]nalysis under the Uniformity Clause of the Pennsylvania
Constitution is generally the same as the analysis under the Equal Protection
Clause of the United States Constitution.” Clifton, 969 A.2d at 1211 n.20; see
Commonwealth v. Molycorp, Inc., 392 A.2d 321, 323 (Pa. 1978). In Molycorp, as
a remedy to a Uniformity Clause violation, the Pennsylvania Supreme Court struck
the additional tax paid by the taxpayer as a result of the violation. In so doing, our
Supreme Court cited with approval the United States Supreme Court’s decision in
Iowa-Des Moines National Bank v. Bennet, 284 U.S. 239 (1931).
In Iowa-Des Moines National Bank, the corporate taxpayer alleged
that Polk County taxing officers taxed the taxpayer at rates in excess of those used
to assess its competitors over a course of years under certain Iowa statutes. The
taxpayer sought mandamus against the county taxing officers to compel them to
18
refund the portion of the taxes that had been illegally exacted due to this disparate
treatment. The Iowa Supreme Court held, however, that the objecting taxpayers
were not entitled to relief. In the state court’s view, the collection error meant only
that “the competing domestic corporations remain, so far as it appears, liable for
the balance of the assessments” that they underpaid. Iowa-Des Moines Nat’l Bank,
284 U.S. at 243. The Iowa Supreme Court held, then, that the only remedy to the
harmed taxpayer was “to await action by the taxing authorities to collect the taxes
remaining due from their competitors or to initiate proceedings themselves to
compel such collection.” Id. at 243-44. In other words, “the discrimination thus
affected was remediable only by correcting the wrong under the state law in favor
of the competitors and not ‘by extending . . . the benefits as of a similar wrong’ to
the petitioners.” Id.at 244.
The United States Supreme Court reversed the Iowa Supreme Court.
It expressly rejected the state court’s refusal to afford affirmative relief to the
offended taxpayer in the face of discriminatory treatment under the notion that the
state could, instead, equalize the tax burden by seeking to recoup the underpaid
taxes from the favored taxpayers. The possibility of recoupment from the favored
taxpayers was, in the Supreme Court’s view, “not material”:
The petitioners’ rights were violated, and the causes of
action arose, when taxes at the lower rate were collected
from their competitors. It may be assumed that all
ground for a claim for refund would have fallen if the
state, promptly upon discovery of the discrimination, had
removed it by collecting the additional taxes from the
favored competitors. By such collection the petitioners’
grievances would have been redressed; for these are not
primarily overassessment. The right invoked is that to
equal treatment; and such treatment will be attained if
either their competitors’ taxes are increased or their own
reduced. But it is well settled that a taxpayer who has
19
been subjected to discriminatory taxation through the
favoring of others in violation of federal law cannot be
required himself to assume the burden of seeking an
increase of the taxes which the others should have paid.
Nor may he be remitted to the necessity of awaiting such
action by the state officials upon their own initiative.
Id. at 247.
In Tredyffrin-Easttown School District v. Valley Forge Music Fair,
Inc., 627 A.2d 814 (Pa. Cmwlth.), appeal denied, 647 A.2d 513 (Pa. 1993), this
Court, citing Molycorp and Iowa-Des Moines National Bank, affirmed a common
pleas court’s ruling that, as a result of its selective enforcement of a local
amusement tax ordinance, the local taxing authority was required to refund
amusement taxes remitted by the objecting taxpayer. The remedy endorsed by this
Court was to place the discriminated taxpayer in the same position as the benefitted
taxpayers. Because of the unequal treatment the objecting taxpayer paid taxes in
excess of the favored taxpayers. The remedy, therefore, was to refund the excess.
Tredyffrin-Easttown Sch. Dist., 627 A.2d at 822-23.
The discrimination in this case derives from the $3 million alternative
limitation in the NLC deduction provision. Although we could strike that
limitation for the 2007 Tax Year and the similar limitations for the tax years
thereafter in an effort to make the statutory scheme uniform, such a statutory
revision would not remedy the wrong suffered by Nextel in the 2007 Tax Year.
Indeed, striking the $3 million cap, as the dissent proposes, would only serve to
highlight the fact that while Nextel paid what it was supposed to pay, many
corporate net income taxpayers in the 2007 Tax Year benefitted from the
discriminatory cap and thus underpaid their corporate net income taxes—i.e., they
benefitted from the unconstitutional provision. Without more, then, an order
20
declaring the $3 million cap unconstitutional and striking it from the statute does
not remedy the constitutional violation.
Under Molycorp, Iowa-Des Moines National Bank, and
Tredyffrin-Easttown School District, the unequal treatment suffered by Nextel
must be remedied, and it can only be remedied in one of two ways—the favored
taxpayers pay more or Nextel pays less. The latter is the only practical solution.
Nextel seeks a refund of corporate net income tax paid in 2007. This is an
appropriate remedy. Like similarly-situated taxpayers with $3 million or less
taxable income in the 2007 Tax Year, Nextel should be permitted under the NLC
deduction provision to reduce its taxable income to $0 by virtue of its positive net
operating loss position that tax year.
In response to the Commonwealth’s concerns, we fully recognize that
our decision in this case could be far-reaching. Nonetheless, our analysis and
remedy is appropriately confined to the Commonwealth, Nextel, and the 2007 Tax
Year. To the extent our decision in this as-applied challenge calls into question the
validity of the NLC deduction provision in any other or even every other context,
the General Assembly should be guided accordingly.
P. KEVIN BROBSON, Judge
21
IN THE COMMONWEALTH COURT OF PENNSYLVANIA
Nextel Communications of the :
Mid-Atlantic, Inc., :
Petitioner :
:
v. : No. 98 F.R. 2012
:
Commonwealth of Pennsylvania, :
Respondent :
ORDER
AND NOW, this 23rd day of November, 2015, it is hereby
ORDERED that the order of the Board of Finance and Revenue in the
above-captioned matter is REVERSED, and the refund petition of Nextel
Communications of the Mid-Atlantic, Inc. (Nextel) is GRANTED. The
Department of Revenue is directed to refund Nextel $3,938,220 in corporate net
income tax paid for the tax year ending December 31, 2007.
Unless exceptions are filed within 30 days pursuant to
Pa. R.A.P. 1571(i), this order shall become final.
P. KEVIN BROBSON, Judge
IN THE COMMONWEALTH COURT OF PENNSYLVANIA
Nextel Communications of the :
Mid-Atlantic, Inc., :
Petitioner :
:
v. : No. 98 F.R. 2012
: Argued: September 16, 2015
Commonwealth of Pennsylvania, :
Respondent :
BEFORE: HONORABLE DAN PELLEGRINI, President Judge
HONORABLE BERNARD L. McGINLEY, Judge
HONORABLE BONNIE BRIGANCE LEADBETTER, Judge
HONORABLE RENÉE COHN JUBELIRER, Judge
HONORABLE MARY HANNAH LEAVITT, Judge
HONORABLE P. KEVIN BROBSON, Judge
HONORABLE ANNE E. COVEY, Judge
CONCURRING AND DISSENTING OPINION
BY PRESIDENT JUDGE PELLEGRINI FILED: November 23, 2015
I agree with the majority that the net loss carryover deduction (NLC
deduction) provision in Section 401(3)4.(c)(1)(A)(II) of the Tax Reform Code of
1971 (Tax Reform Code)1 that allows a net loss deduction that is the greater of the
flat percentage of net losses or of a flat capped amount violates the uniformity
requirement (Article VIII, Section 1) of the Pennsylvania Constitution (Uniformity
Clause). As the majority cogently explains:
To the extent the General Assembly exercises its power to
tax property, it cannot set a valuation threshold that, in
1
Act of March 4, 1971, P.L. 6, as amended, 72 P.S. §7401(3)4.(c)(1)(A)(II).
effect, exempts some property owners from the tax entirely.
The Commonwealth offers no reasoned or persuasive
argument to eschew this precedent in this case. Here, the
General Assembly has elected to tax property—i.e.,
corporate net income. It has also allowed taxpayers to
deduct from their taxable income carryover net losses from
prior years. By capping that deduction at the greater of $3
million or 12.5% of taxable income, however, the General
Assembly has favored taxpayers whose property (i.e.,
taxable income) is valued at $3 million or less. To the
extent these taxpayers are in a positive net loss carryover
position, they pay no corporate net income tax—i.e., they
have no tax burden. A similarly-situated taxpayer with
more than $3 million in taxable income, however, cannot
avoid paying tax under the NLC deduction provision. The
distinction is based solely on asset value, which is, under
Cope’s Estate, “unjust, arbitrary, and illegal.” Id. at 81.
Moreover, the fact that the NLC deduction provision
enabled 98.8% of taxpayers in a positive net loss carryover
position to avoid paying any tax in 2007, leaving 1.2% of
similarly-situated taxpayers to pay some tax, “illustrates the
injustice and inequality that must result from such special
legislation.” Id. at 82. (footnote omitted).
Slip Opinion, p. 13.
The majority, however, pretends that because Nextel is purportedly not
making a facial challenge, what is “only” to be declared unconstitutional is the NLC
deduction provision as applied to Nextel for the 2007 Tax Year. Realizing the effect
that its opinion would have, the majority opinion states that “[t]o the extent our
decision in this as-applied challenge calls into question the validity of the NLC
deduction provision in any other or even every other context, the General Assembly
should be guided accordingly.” Slip Opinion, p. 19. Unless our case law means
nothing, no matter whether you call it – an “as applied” challenge or a facial
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challenge – the net effect of our holding is that Section 401(3)4.(c)(1)(A)(II) can no
longer cap the amount of NLC deductions for all taxpayers. As a result, we must go
on to determine whether the flat capped NLC deduction should be stricken making
that provision uniform or, as the majority does, eliminate all caps on NLC
deductions.2
Section 1925 of the Statutory Construction Act, 1 Pa. C.S. §1925,
provides, in relevant part:
The provisions of every statute shall be severable. If any
provision of any statute … is held invalid, the remainder of
the statute … shall not be affected thereby, unless the court
finds that the valid provisions of the statute are so
essentially and inseparably connected with, and so depend
upon, the void provision … that it cannot be presumed the
General Assembly would have enacted the remaining valid
provisions without the void one; or unless the court finds
that the remaining valid provisions, standing alone, are
incomplete and are incapable of being executed in
accordance with the legislative intent.
Under the provisions, the unconstitutional provisions should be severed
from their constitutional counterparts unless the valid provisions are so essentially
and inseparably connected with, and so dependent upon, the void provision or
application so that it cannot be presumed the General Assembly would have enacted
2
The majority relies on Iowa-Des Moines Nat. Bank v. Bennett, 52 S.Ct. 133 (1931) and
Tredyffrin-Easttown Sch. Dist. v. Valley Forge Music Fair, Inc., 627 A.2d 814, 821 (Pa. Cmwlth.
1993), but those cases have nothing to do with how a tax statute should be interpreted once a
provision is found unconstitutional to give effect to the General Assembly’s intention. They are not
applicable because neither of those cases dealt with an unconstitutional tax statute, but with the
unequal enforcement of a constitutional statute by administrative officials.
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the remaining valid provisions without the voided one or that the remaining valid
provisions, standing alone, are incomplete and incapable of being executed in
accordance with the legislative intent. Pennsylvanians Against Gambling Expansion
Fund, Inc. v. Commonwealth, 877 A.2d 383 (Pa. 2005).
The NLC deduction contained in Section 401(3)4.(c)(1)(A)(II) is part of
the “Definition” section of the Tax Reform Code which provides, in relevant part:
(A) (I) For taxable years beginning before January 1, 2007,
two million dollars ($2,000,000);
(II) For taxable years beginning after December 31, 2006,
the greater of twelve and one-half per cent of taxable
income as determined under subclause 1 or, if applicable,
subclause 2 or three million dollars ($3,000,000);
(III) For taxable years beginning after December 31, 2008,
the greater of fifteen per cent of taxable income as
determined under subclause 1 or, if applicable, subclause
2 or three million dollars ($3,000,000);
(IV) For taxable years beginning after December 31, 2009,
the greater of twenty per cent of taxable income as
determined under subclause 1 or, if applicable, subclause
2 or three million dollars ($3,000,000);
(V) For taxable years beginning after December 31, 2013,
the greater of twenty-five per cent of taxable income as
determined under subclause 1 or, if applicable, subclause
2 or four million dollars ($4,000,000);
(VI) For taxable years beginning after December 31, 2014,
the greater of thirty per cent of taxable income as
determined under subclause 1 or, if applicable, subclause
2 or five million dollars ($5,000,000).
72 P.S. §7401(3)4.(c)(1)(A) (emphasis added).
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It is clear that the General Assembly wanted to limit NLC deductions
every tax year – with both a flat and percentage cap on deductions. The majority
would strike all caps on deductions, which is directly against the legislative scheme
of the placement of caps on NLC deductions. If the unconstitutional flat cap
deduction is severed for each relevant year highlighted in bold, the uniform
percentage deduction would remain, which would be available to all taxpayers.
Severing the flat cap provisions would carry out the legislative intent to place a
limitation on NLC deductions for each year.
Because the remaining valid provisions of Section 7401(3)4.(c)(1)(A)
carry out the intent of the General Assembly, protect the public purse, and are
complete and capable of being administered without the severed provisions, I dissent
from that portion of the majority opinion that removes the cap on all NLC deductions.
____________________________________
DAN PELLEGRINI, President Judge
Judge Leadbetter joins in this concurring and dissenting opinion.
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