In Mount Airy #1, LLC,¹ the Pennsylvania Supreme Court (Court) held that Section 1403(c) of the Pennsylvania Race Horse Development and Gaming Act (the Gaming Act), which imposes a municipal local share assessment (LSA) on casinos based on the greater of $10 million or 2% of gross terminal revenue (GTR), violates the Uniformity Clause of the Pennsylvania Constitution because it creates variable tax rates. Ultimately, the Court severed the offending provisions from the Gaming Act, but stayed its decision for 120 days to allow the General Assembly an opportunity to craft a constitutional LSA.

Mount Airy #1 LLC (Mount Airy) operates a casino in Mount Pocono, Pennsylvania. Mount Airy claimed that the municipal portion of the LSA, on its face and as applied, violated the Uniformity Clause of the Pennsylvania Constitution and the Equal Protection Clause of the US Constitution. Mount Airy brought this claim before the Pennsylvania Supreme Court in its exclusive and original jurisdiction.

Justice Wecht's majority opinion

The majority opinion rejected the Pennsylvania Department of Revenue's (Department) argument that the LSA is constitutional because it satisfies the Equal Protection Clause of the US Constitution, noting that the Uniformity Clause imposes more stringent requirements. The Court explained that a tax does not withstand a Uniformity Clause challenge if it is only "rationally related to [a] legitimate state purpose" because the rational relation test of the Equal Protection Clause serves as a floor not a ceiling. Rather, the Court articulated a new test, providing that, for Uniformity Clause purposes, "the relevant inquiry is whether the validity of a tax classification is based upon some legitimate distinction between the classes that provides a non-arbitrary, reasonable, and just basis for the disparate treatment."

In applying its newly announced test, the majority found that the LSA lacks a valid, non-arbitrary government purpose because it has the functional equivalent of two separate municipal assessments: (1) a $10 million lump sum that all casinos must pay; and (2) a tax on 2% of GTR in excess of $500 million. The LSA is "patently discriminatory" because it effectuates two separate tax brackets premised solely on quantitative distinctions. As the opinion states, " … such quantitative distinctions lack uniformity because any 'classification that is based solely on a difference in quantity of precisely the same kind of property is necessarily unjust, arbitrary, and illegal.'"

The majority also rejected Mount Airy's request for monetary damages, finding such are not an appropriate remedy for a Uniformity Clause violation.

Lastly, the Court severed the offending provisions from the Gaming Act, but stayed its decision for 120 days to allow the General Assembly an opportunity to craft a constitutional LSA. In a footnote, the Court also noted that decisions from the Pennsylvania Supreme Court invalidating a tax statute take effect as of the date of the decision, and do not apply retroactively.

Justice Todd's concurring and dissenting opinion

Justice Todd's opinion concurred with the majority that the LSA violates the Uniformity Clause because it creates a variable-rate tax. Justice Todd asserted, however, that Section 1403(c) should not be struck altogether under the Doctrine of Severability. The legislature explicitly provided that one bad provision of the Gaming Act does not taint all others. Section 1403(c)(3) contains the LSA and is the only provision that Mount Airy challenged. Therefore, Justice Todd posited that Section 1403(c)(2), which imposes a 4% county share assessment on casinos located in Philadelphia and a 2% county share assessment for casinos located elsewhere, should be severed from the infirm provision (Section 1403(c)(3)), and remain in effect.

Chief Justice Saylor, concurring and dissenting opinion

Chief Justice Saylor's opinion dissented from the majority's conclusion that the LSA is facially unconstitutional, and argued that more factual development is needed to determine the LSA's validity. In dissenting, Justice Saylor made two main points.

First, the Chief Justice argued that the Uniformity Clause should not have a dispositive role in the analysis of this case because the LSA is specifically tailored to the gaming industry, which is sui generis in relation to all other taxes the Court has analyzed under uniformity. The gaming industry differs from other areas of commerce in that Pennsylvania issues a limited number of licenses in each geographic locality. This exclusive licensure insulates casinos in Pennsylvania from free-market adversity, thereby affecting a near monopoly in local commerce. Therefore, despite a putative lack of uniformity, factors such as the maintenance of a legal monopoly and a closely regulated industry weigh in favor of applying a different analysis to the validity of the LSA.

Chief Justice Saylor's second major point was that the LSA is not arbitrary, and did serve a valid government concern because it funds additional costs that municipalities necessarily bear when they host a casino. Though not explicitly stated by the General Assembly in the Gaming Act's legislative history, the LSA has a legitimate purpose for creating different classifications on the same tax base because casinos generate negative externalities into their communities, such as "increased vehicular traffic, the presence of a large number of patrons, and the concomitant potential for substantial consumption of municipal resources such as fire and police services." The LSA provides "a minimum level of indemnification to host municipalities while also ensuring that, if a casino exceeded an extremely high threshold, it would pay even more as a consequence of the extra traffic and patronage needed to reach that level of gross revenues."

Potential effects of Mount Airy decision on net loss carryforward litigation

Nextel

On October 18, 2016 the Pennsylvania Supreme Court granted oral argument to the parties in Nextel, and directed them to file additional briefs to address the Mount Airy #1 decision. A briefing schedule and argument date are forthcoming.

In Nextel, the Commonwealth Court of Pennsylvania (commonwealth court) held the statutory limitation on the net-loss carryover deduction (NLC) on the greater of 12.5% of taxable income or $3 million violated the Uniformity Clause as applied to the taxpayer for 2007. The commonwealth court premised its decision on the disparate effect the NLC limitation caused between the taxpayer (which paid tax as a result of the limitation), and other taxpayers whose taxable income did not exceed the limitation and, therefore, paid no tax that year. The commonwealth court ruled that the taxpayer was entitled to a refund for the amount of tax paid, effectively eliminating both the dollar and percentage caps.

In his concurring and dissenting opinion, Judge Pellegrini opined that, even though the challenge was "as applied," it will still serve as precedent for subsequent challenges to the NLC cap, so, as a practical matter, was a facial challenge. Judge Pellegrini also noted that the commonwealth court could have severed the unconstitutional flat dollar cap while upholding the uniform percentage cap. This, in Pellegrini's view, would preserve uniformity while simultaneously fulfilling the legislature's intent to limit NLC deductions.

RB Alden

On June 15, 2016, the commonwealth court issued a decision in RB Alden, and in relying on its earlier decision in Nextel, held that Pennsylvania's $2 million statutory cap on NLCs in place for tax year 2006 is unconstitutional in violation of the Uniformity Clause. As such, the commonwealth court ordered the Department to calculate the petitioner's corporate net income tax without limiting its NLC. It should be noted that the NLC subparagraph for the tax year applicable to RB Alden imposed a dollar cap of $2 million and no percentage cap. Thus, Judge Pellegrini, who wrote the RB Alden and the Nextel decisions, continued his view that the dollar cap facially violates the Uniformity Clause.

Implications

Mount Airy #1 will immediately affect the gaming industry and the future of the LSA. The reasoning of this case will also influence the pending NLC decisions in Nextel and RB Alden, as is indicated by the Court's request to the Nextel litigants for briefing on Mount Airy #1. As Justice Saylor pointed out, however, distinctions between the Gaming Act and other tax provisions may require the application of somewhat different analyses.

The LSA at issue in Mount Airy #1 and NLC cap at issue in Nextel and RB Alden are somewhat parallel. The LSA contains a flat tax, plus a uniform percentage for amounts exceeding the cap. The NLC is capped at the greater of a dollar amount or a percentage of taxable income. Both provisions appear to impose a uniform rate, but, as a result of the flat minimum amount ($10 million) in the LSA and the dollar and percentage NLC caps, the effective rate paid by similarly situated taxpayers may differ. Taking these parallels into account, one wonders whether — and, if so, how — the majority's statement in Mount Airy #1 that"[while] Uniformity Clause jurisprudence affords the General Assembly a bit more flexibility in the context of corporate tax, it does not countenance variable-rate taxes like the one sub judice" foreshadows how strictly the Court may construe the Uniformity Clause in Nextel and RB Alden.

Putting aside how the Court may rule on the substantive uniformity issue in Nextel and RB Alden, one turns to the question of remedy. In footnote 11 of the majority's opinion in Mount Airy #1, the Court cites Oz Gas, Ltd. v. Warren Area Sch. Dist. for the proposition that "a decision of this Court invalidating a tax statute takes effect as of the date of the decision and is not to be applied retroactively." The Court, therefore, deprives Mount Airy of a refund (because it would constitute retroactive relief), and charges the legislature to craft a constitutional LSA on a prospective basis. If the Court were to apply this logic to Nextel and RB Alden, neither party would receive a refund and the legislature would be charged with the task of crafting a constitutional NLC provision on a prospective basis.

That said, the majority's decision on the remedy in Mount Airy #1 may not affect the remedy in the NLC cases because of key distinctions between the taxpayers in the NLC cases and Mount Airy #1.

———————————————

———————————————
ENDNOTES

¹ Mount Airy #1, LLC v. Pennsylvania Dept. of Rev., No. 34 EM 2015 (Pa. S. Ct. Sept. 28, 2016).