On April 5, 2017, the Pennsylvania Supreme Court (Court) heard oral argument in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth.¹ The question presented by this case is whether the statutory cap imposed on Pennsylvania's net loss carryover (NLC) deduction violates the Uniformity Clause of the Pennsylvania Constitution and, if so, what is the proper remedy?²

The lower court decision

On November 23, 2015, the Commonwealth Court found that the statute imposing the NLC cap violates the Uniformity Clause of the Pennsylvania Constitution³ by creating classes of taxpayers according to their taxable income, and concluded that classifications based solely on asset value are unjust, arbitrary and illegal. For the tax year at issue, the NLC deduction was limited to the greater of 12.5% of the taxpayer's taxable income or $3 million.⁴ Under the statute, Nextel could only deduct $5.6 million of NOLs in computing its 2007 corporate net income tax (CNIT) liability,⁵ even though it had $150 million of NLCs. Taxpayers with NLCs and taxable income less than $3 million, however, were able to reduce their taxable income to zero.

The Commonwealth Court stated that its holding was not a per se rejection of the NLC cap, but rather applied solely to Nextel's facts. Although the Commonwealth Court's decision only addressed the $3 million cap, the Commonwealth Court granted Nextel a full refund of all of the CNIT it paid for its 2007 return, which effectively eliminated the 12.5% cap.

Argument before the Court

Uniformity

During oral argument, the justices appeared to be generally comfortable with the question of whether the NLC cap violates the Uniformity Clause. That said, the justices did not try to distinguish between the potential effects of applying the dollar cap versus the percentage cap. Nextel utilized the percentage cap, but it only challenged the dollar cap in this appeal, which raised an issue of standing that neither the Commonwealth — nor the Pennsylvania Supreme Court sua sponte — raised.

As applied vs facial challenge

The justices spent a significant amount of time on the question of whether this constitutional challenge is "as applied" or "facial" (i.e., applied only to the specific taxpayer in the case versus applies to all). For example, Justice Wecht asked Nextel's counsel whether it is the litigant's or the Court's choice to make such a determination. Nextel's counsel argued that either way, Nextel's challenge was clearly "as applied" because the facts of this case are unique. Nextel had years of losses leading up to a single year of massive income exceeding the statutory NLC cap, followed by years of losses precluding Nextel from using its NLCs in the future. Contrast Nextel's position with Judge Pellegrini's dissenting opinion in the Commonwealth Court, in which he said that, "[u]nless [Pennsylvania] case law means nothing, no matter whether you call it — an 'as applied' challenge or a facial challenge — the net effect of our holding is that the [statute] can no longer cap the amount of NLC deductions for all taxpayers."⁶

Remedy

The Court wrestled with both counsels vigorously over the question of the proper remedy to apply if the Court were to hold that the NLC cap violates the Uniformity Clause. If the Court finds a uniformity violation, it will have to decide whether to grant retroactive relief like the Commonwealth Court, or whether it is bound to grant only prospective relief as in another recent Uniformity Clause decision — Mount Airy #1 v. Pa. Dept. of Rev.⁷ Justice Donahue pointed to footnote 11 of the Mount Airy decision, in which the Court stated:⁸

"Pennsylvania law does not provide for a cause of action akin to 42 U.S.C. Section 1983, and this Court has never held that monetary damages may be awarded based upon a Uniformity Clause violation … As we have explained in the past, "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." Oz Gas, Ltd. v. Warren Area Sch. Dist., 938 A.2d 274, 285 (Pa. 2007). Thus, Mount Airy is not entitled to an award of damages for its prior municipal local share assessment payments."

Counsel for Nextel argued that this footnote is dicta, and is only an accurate statement of the law to the extent that the Court is announcing a new rule of law. Counsel further argued that a decision invalidating the NLC cap is consistent with over 80 years of Pennsylvania precedent, and would be at most an evolution of the law, not a new rule of law.

The Court further inquired as to what retroactive remedy may be appropriate. Justice Baer posited that perhaps an appropriate remedy would be to sever the dollar cap alone, and leave the percentage cap in place. Counsel for the Commonwealth seemed to agree that such a remedy may be appropriate. On this line of questioning, Justice Wecht asked Nextel's counsel whether the law requires the Court to grant relief to a litigant that prevails on an issue, pointing out that the Court's decision here may very well be a pyrrhic victory for the taxpayer regardless of whether the remedy is prospective or retroactive.

Implications

While questions from the bench at oral argument are not necessarily an accurate indicator of the outcome of a case, they can provide at least some insight into the issues with which a court may be wrestling. Based on our experience, the Pennsylvania Supreme Court could take between three to six months to issue its decision. Thus, Pennsylvania CNIT taxpayers that did not utilize their NLCs due to a dollar or percentage statutory cap should consider filing protective refund claims consistent with the Commonwealth Court's ruling in Nextel.

———————————————

———————————————
ENDNOTES

¹ Nextel Communications v. Commonwealth, Aplt., Dkt. No. 6 EAP 2016 (Pa. S. Ct. oral argument April 5, 2017).

² Nextel Comm. of the Mid-Atlantic, Inc. v. Pennsylvania, No. 98 F.R. 2012 (Pa. Cmnwlth. Ct. Nov. 2015).

³ Pa. Const. Art. VIII, Section 1 ("All taxes shall be uniform, upon the same class of subjects, within the territorial limits of the authority levying the tax, and shall be levied and collected under general laws.")

⁴ For tax years beginning after December 31, 2014, the NLC deduction is capped at the greater of 30% of taxable income or $5 million. 72 P.S. Section 7401(3)4.(c)(1)(A)(VI).

⁵ 12.5% of the Nextel's $45 million of taxable income, prior to the utilization of NLCs.

⁶ Nextel of the Mid-Atlantic v. Commw., 98 F.R. 2012 (Commw. Ct., Nov. 23, 2015).

⁷ Mount Airy #1 v. Pa. Dept. of Rev., 34 EM 2015 (Sept. 28, 2016).

⁸ (emphasis added) Id.