October 24, 2017 Pennsylvania Supreme Court affirms in Nextel that NOL 'dollar cap' violates uniformity but reverses remedy and leaves many important questions unanswered On October 18, 2017, the Pennsylvania Supreme Court (Court) issued its decision in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth.1 The Commonwealth of Pennsylvania brought this appeal before the Court after losing at Commonwealth Court. The question presented was whether the statutory $3 million 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 Court affirmed the Commonwealth Court's holding that, as applied to Nextel, "the NLC is unconstitutional as written because of its inclusion of the $3 million flat deduction."3The Court reversed the refund awarded to Nextel by the Commonwealth Court, and instead severed only the $3 million flat cap on NLCs from the NLC statute — not the entire cap including the percentage cap. The Court's decision handed Nextel a victory on the issue, but denied the company any corresponding tax relief. It also leaves several important questions unanswered — most importantly, whether the percentage cap is constitutional. Background On November 23, 2015, the Commonwealth Court found that the statute imposing the NLC cap violates the Uniformity Clause of the Pennsylvania Constitution by creating classes of taxpayers based on 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. Furthermore, many taxpayers with NLCs and taxable income of less than $3 million were able to reduce their taxable income to zero. The majority of the Commonwealth Court stated that its holding was not a per se rejection of the NLC cap, but rather was only "as-applied" to Nextel's facts. Though the Commonwealth Court's decision only directly addressed the $3 million cap, the Court granted Nextel a full refund of all of the CNIT it paid for its 2007 return, notwithstanding that Nextel was only subject to the 12.5% cap. Supreme Court decision Uniformity The Court affirmed the Commonwealth Court's holding that the $3 million NLCcap violates the Uniformity Clause. Citing its recent decision in Mount Airy #1, LLC,6 the Court agreed with the Commonwealth Court's reasoning that the NLC creates two classes of similarly situated taxpayers, treats them differently based solely on their taxable income and is, therefore, "arbitrary and unreasonable."7 The Court rejected the Commonwealth's position that the Uniformity Clause requires only the nominal (as opposed to effective) tax rate to be uniform, and affirmed that the same Uniformity Clause analysis applies to corporate income tax and personal income tax. Severability Next, the Court reversed the Commonwealth Court by holding that only the $3 million NLC cap must be severed from the statute, thus leaving the 12.5% NLC cap intact. In its analysis, the Court considered three options: (1) Sever only the flat $3 million dollar cap from the NLC statute (2) Sever both the $3 million and 12.5% deduction caps and allow corporations to claim an unlimited portion of their NLC or (3) Strike down the entire NLC statute as unconstitutional and prohibit corporations from deducting any NLC8 In evaluating these options, the Court focused on the legislative intent in enacting the NLC. The Court determined that the legislature intended to "balance the twin policy objectives of encouraging investment (by allowing corporations to deduct some of the losses they sustain when making such investments against their future revenues), and ensuring that the Commonwealth's financial health is maintained (by capping the amount of this deduction)."9 The Court reasoned that severing only the dollar cap satisfies both of these legislative policy objectives, whereas the other two options do not.10 As applied vs facial constitutional violation The Court held that the dollar cap violated the Uniformity Clause "as applied" to Nextel's facts only, as opposed to being a "facial" violation. This holding could be interpreted to mean that the decision is completely limited to Nextel's specific set of facts and does not affect any other taxpayer. As the concurring opinion points out, however, it would likely be difficult for the Court to reach a different decision for any other taxpayer.11 Important questions left unanswered While the Court was silent on the constitutionality of the percentage cap, it did not sever the percentage cap. Because the Court did not rule on the constitutionality of the percentage cap, another round of litigation on this issue could erupt. On the other hand, larger taxpayers may find that challenging the constitutionality of the percentage cap in light of the Court's decision results only in a pyrrhic victory. Although the Court wrestled vigorously during oral argument with the question of whether it must grant retroactive or prospective relief, the opinion itself is silent on this matter. Because the Court reversed the refund here and issued an as applied decision with no future impact on any taxpayer other than Nextel, the Court did not need to step into the quagmire of whether the recent Mount Airy decision could be read to allow only prospective relief.12 That said, the Court will have an opportunity to address the prospective vs. retroactive question in a similar case (RB Alden v. Comm'w, 60 MAP 2017), which is currently before the Court and challenges the constitutionality of the dollar cap for a year in which there was no percentage cap. On October 17, 2017, the Pennsylvania House of Representatives passed an amended version of H.B. 542 in which the dollar cap is eliminated for tax years beginning after December 31, 2017, and the percentage cap is increased to 35% (and then increases to 45% for tax years beginning after December 31, 2018). H.B. 542 would specifically require the Secretary of Revenue to publish a notice in the Pennsylvania Bulletin if the Court decides that any part of the NLC cap is determined to be unconstitutional. It is unclear how the Court's decision and the issues it left open will influence the General Assembly in drafting further amendments to H.B. 542 and the NLC statute, but clearly its legislative members are watching closely and will likely react to the Court's decision. ———————————————
——————————————— 1 Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, No. 6 EAP 2016 (Pa. S. Ct. Oct. 18, 2017) (hereinafter Nextel v. Commonwealth). 2 Nextel Comm. of the Mid-Atlantic, Inc. v. Pennsylvania, No. 98 F.R. 2012 (Pa. Cmnwlth. Ct. Nov. 2015). 3 Nextel v. Commonwealth, Slip Op. at 29. 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. § 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 Mount Airy #1, LLC, v. Department of Revenue, 154 A.3d 268 (Pa. 2016). 7 Nextel v. Commonwealth, Slip Op. at 26-27 (stating that the Court's "holding in Mt. Airy reaffirmed the central tenet of our Court's Uniformity Clause jurisprudence: a taxing statute [that] classifies similarly situated taxpayers solely on the basis of their income, and thereby places differing tax burdens on each class as a result, is forbidden"). 8 Nextel v. Commonwealth, Slip Op. at 33-34. 9 Id. at 36. 10 Id. (finding that, if the Court selected the first option, then "each corporation will be entitled to avail itself of [an NLC] deduction, as the legislature intended, but such deduction will be equally valuable to all corporations during that year, no matter what their taxable income.") 11 Nextel v. Commonwealth, Concurring Slip Op. at 2. (Baer, J., concurring)(finding the distinction between an "as-applied" and a "facial" challenge to be "arguably meaningless in this case given the future effect of [the] decision."); Justice Baer, Donohue and Wecht also clarified in the concurring opinion that the holding of this decision "declares the NLC unconstitutional on its face." Id. 12 Mount Airy #1 v. Pa. Dept. of Rev., supra note 7. | |||||||||
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