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Nextel Communications of Mid-Atlantic, Inc. v. Commonwealth

Supreme Court of Pennsylvania

October 18, 2017

NEXTEL COMMUNICATIONS OF THE MID-ATLANTIC, INC., Appellee
v.
COMMONWEALTH OF PENNSYLVANIA, DEPARTMENT OF REVENUE Appellant

          ARGUED: April 5, 2017

         Appeal from the Judgment of the Commonwealth Court entered on December 30, 2015 at No. 98 F.R. 2012

          SAYLOR, C.J., BAER, TODD, DONOHUE, DOUGHERTY, WECHT, MUNDY, JJ.

          OPINION

          TODD JUSTICE

         In this direct appeal, we are called upon to determine whether the "net loss carryover" provision of the Pennsylvania Revenue Code for tax year 2007 ("NLC")[1] - which restricted the amount of loss a corporation could carry over from prior years as a deduction against its 2007 taxable income to whichever is greater, 12.5% of the corporation's 2007 taxable income or $3 million - violates Article 8, Section 1 of the Pennsylvania Constitution ("the Uniformity Clause").[2] We affirm the Commonwealth Court's holding that the NLC, as applied to Appellee, Nextel Communications ("Nextel"), violates the Uniformity Clause. However, we also find that the portion of the NLC which creates the violation - the $3 million flat deduction - may be severed from the remainder of the statute, while still enabling the statute to operate as the legislature intended. Thus, we reverse the order of the Commonwealth Court eliminating any caps on net loss deductions for tax year 2007; and, correspondingly, we reverse its direction to Appellant, the Pennsylvania Department of Revenue ("Department"), to refund $3, 938, 220 to Nextel, which was the amount of its 2007 net income tax payment to the Commonwealth.

         I. Procedural History

         Nextel, which is incorporated in the state of Delaware, is a provider of various mobile telecommunication services. In 2007, Nextel earned $45, 053, 282 in taxable income on its business activities in the Commonwealth. Under the NLC, Nextel was entitled to deduct from its 2007 taxable income the net losses it sustained in prior tax years in the amount of $3 million or 12.5% of its 2007 taxable income, whichever total was greater. In 2007, Nextel had a cumulative net loss dating from the tax year 1997 of $150, 636, 792.[3] Because 12.5% of Nextel's 2007 taxable income amounted to $5, 631, 660, and, hence, was greater than $3 million, Nextel claimed the 12.5% amount as a net loss deduction, thereby reducing its taxable income for 2007 to $39, 421, 622. Under the corporate net income tax rate of 9.9%, [4] Nextel's total tax liability to the Commonwealth on this adjusted income was $3, 938, 220, which Nextel paid to the Department.

         Thereafter, Nextel filed a refund claim with the Department's Board of Appeals for the full amount of its 2007 tax payment, claiming, inter alia, that the NLC violated the Uniformity Clause of the Pennsylvania Constitution by capping the amount of its prior net loss that it could carry over into tax year 2007 at 12.5% of its taxable income. This claim was denied by the Board on the basis that it did not have the legal authority to address a constitutional challenge. Nextel then petitioned the Board of Finance and Revenue, again claiming its entitlement to a refund and asserting the right to carry over all prior net losses for use as a deduction without limitation.[5] The Board of Finance and Revenue denied the petition and rejected Nextel's constitutional argument, noting that it was not empowered to pass on questions of a taxing statute's validity under our constitution, but, rather, could only apply the law as it was written.

         Nextel appealed to the Commonwealth Court, which, in a split en banc published decision, reversed the decision of the Board of Finance and Revenue.[6] Nextel Communications of the Mid-Atlantic, Inc., v. Commonwealth of Pennsylvania, Department of Revenue, 129 A.3d 1 (Pa. Cmwlth. 2015). The majority first rejected the Department's argument that, because all corporations were subject to the same statutory rate of 9.9% on their taxable income, there was no Uniformity Clause violation. The majority noted that it is the effect of the application of the particular formula or method used to calculate a tax which determines whether a Uniformity Clause violation occurs.

         In considering the effect of the NLC on various corporations' taxable income, the majority determined that, as written, it allowed some corporate taxpayers - those with income of $3 million or less - to reduce their tax liability to zero in the tax year 2007, if they had prior net operating losses of $3 million or more. By contrast, it imposed tax liability on other corporations with income in excess of $3 million and prior net operating losses which equaled or exceeded their taxable income, because those corporations' net loss deduction was capped (at the greater of $3 million or 12.5% of their taxable income).

         The majority next examined whether the NLC's application to corporate taxpayers on the basis of taxable income was reasonable, and rationally related to a legitimate state purpose. The majority observed that our Court had previously held, in In re Cope's Estate, 43 A. 79 (Pa. 1899) (invalidating an inheritance tax provision that exempted estates worth $5, 000 or less from paying that tax), that a tax rate based on the monetary value of the property taxed, which has the effect of causing different groups of taxpayers from the same class to bear unequal burdens of taxation, or which exempts some taxpayers in the class from paying any tax at all, offends the Uniformity Clause. The majority reasoned that, because the NLC was structured to assess a corporation's tax liability on the basis of the value of a corporation's taxable income, in operation, the NLC enabled the majority of corporations with taxable income (98.8%) to avoid paying any taxes at all in 2007; but, because of the limitation on the amount of net loss carryover which a corporation was permitted to deduct, it forced a minority of those taxpayers (1.2%) to incur tax liability.[7] The majority concluded that, because this disparate tax treatment was "based solely on asset value, " the NLC was the same type of taxing statute our Court held to be forbidden under the Uniformity Clause in Cope's Estate, and was likewise unconstitutional. Nextel, 129 A.3d at 11.

         The majority was unpersuaded by the Department's argument that the General Assembly was justified in limiting the amount of loss from a prior tax year which a corporation could carry over because of budgetary concerns that an unlimited deduction would result in too much lost revenue. The majority acknowledged the General Assembly's right to limit such deductions, but viewed this right as constrained by the fundamental requirement that any such limitation comport with the Pennsylvania Constitution, and, thus, in the majority's view, this concern could not excuse the NLC's violation of the Uniformity Clause.

         Having determined that the NLC was unconstitutional, the majority next turned to the issue of the appropriate remedy. The majority refused to strike the NLC in its entirety from the Revenue Code as suggested by the Department, reasoning that Nextel had not made a facial challenge to the constitutionality of the NLC, nor, in reaching its decision, had the court found the NLC to be facially unconstitutional. Instead, the majority noted that Nextel had claimed only that the NLC was unconstitutional as applied to it for the 2007 tax year, and, thus, the majority concluded that the appropriate relief should be limited to remedying the improper application of the NLC to Nextel's taxable income for that tax year.

         Observing that the Uniformity Clause and the Equal Protection Clause of the United States Constitution have generally been analyzed in the same fashion, the majority found guidance from cases in which a taxpayer successfully established that a state engaged in discriminatory enforcement of its taxing laws, resulting in the taxpayer paying more than other similarly situated taxpayers, and, as a remedy, the taxpayer was afforded relief from the improperly assessed additional tax liability. See Nextel, 129 A.3d at 12-13 (citing Commonwealth v. Molycorp, 392 A.2d 321 (Pa. 1978) (after successful challenge by corporation under the Uniformity Clause to the Department's selective imposition of tax penalties for underpayment of corporate taxes against one group of corporate taxpayers, our Court determined that the proper remedy was to reverse the Department's assessment of a penalty against the corporation); Iowa-Des Moines National Bank v. Bennett, 284 U.S. 239 (1931) (bank which was successful in its equal protection challenge to county taxing authority's assessment of taxes on it at a higher rate than its competitors was entitled to a refund of the extra taxes it had paid, and it was not a sufficient remedy to require the bank to seek to compel the collection of additional taxes against its competitors, or to wait for the taxing authority to collect the additional taxes of its own volition); Tredyffrin-Easttown School District v. Valley Forge Music Fair, Inc., 627 A.2d 814 (Pa. Cmwlth. 1993) (business that successfully challenged enforcement of amusement tax ordinance which resulted in it paying more in taxes than other similarly situated businesses was entitled to a refund of the excess taxes it paid)).

         The majority reasoned that, like the taxpayers in those cases, Nextel established that it was subject to unequal treatment vis-a-vis other corporate taxpayers and was entitled to a similar remedy. While acknowledging that it could strike the flat $3 million deduction for the 2007 tax year, which would then make the 12.5% deduction uniformly apply to all corporate taxpayers, it rejected that alternative as, in its view, this would not correct the constitutional violation suffered by Nextel and "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., benefitted from the unconstitutional provision." Nextel, 129 A.3d at 13 (emphasis original). The majority thus viewed the "only practical solution" to be to allow Nextel to use its prior operating losses to reduce its corporate taxable income to zero in the 2007 tax year, and, thus, pay no taxes, just as did 98.8% of corporations in that tax year - i.e., those with $3 million or less of taxable income and an equivalent or greater amount of prior net loss deductions for that tax year. Id.

         The majority, perceiving there would possibly be significant deleterious revenue consequences to the Commonwealth of its decision, attempted to limit its scope "to the [Department], Nextel and the 2007 Tax Year." Id. The majority further opined 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 appropriately." Id. In accordance with its decision, the Commonwealth Court entered an order directing the Department to refund to Nextel the $3, 938, 230 it had paid in corporate net income tax for tax year 2007.

         Then-President Judge, now-Judge, Pellegrini authored a concurring and dissenting opinion which was joined by Judge Leadbetter. While agreeing with the majority that the NLC violated the Uniformity Clause, Judge Pellegrini dissented from the majority's proposed remedy. Judge Pellegrini disagreed that the majority's decision could be restricted in its effect only to a determination of the amount of tax Nextel owed for tax year 2007. By contrast, he viewed the majority's characterization of Nextel's challenge as being an "as applied" one to be irrelevant to the impact of its holding, inasmuch as he viewed the practical effect of the court's decision as allowing all corporate taxpayers to, henceforth, take an unlimited net loss carryover deduction.

         Judge Pellegrini opined that he would, instead, apply Section 1925 of the Statutory Construction Act of 1972 ("SCA"), 1 Pa.C.S. § 1925, which allows courts to sever unconstitutional provisions of a statute from the remaining constitutional portions "unless the court finds that the valid provisions . . . 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 . . . that the remaining valid provisions, standing alone, are incomplete and are incapable of being executed in accordance with the legislative intent." 1 Pa.C.S. § 1925. Judge Pellegrini noted that the structure of the NLC, and similar net loss carryover provisions in the Revenue Code for subsequent tax years 2009, 2010, 2014 and 2015, [8] reflected the General Assembly's intent to limit the net loss carryover deduction a corporation could utilize in each tax year by capping it. Consequently, in Judge Pellegrini's view, the majority's decision to eliminate all caps on the amount of net loss a corporation could carry over was directly contrary to this legislative intent. Judge Pellegrini pointed out, however, that in each of these net loss carryover provisions of the Revenue Code, the flat dollar deduction could be severed from the percentage deduction, thereby leaving the percentage deduction available to all taxpayers. Judge Pellegrini deemed this to be the most appropriate course of action as it would carry out the legislative intent to limit net loss carryover deductions for a given tax year, while also protecting the public purse.

         The Department filed a direct appeal with our Court, raising two issues: (1) whether the NLC violates the Uniformity Clause by capping the amount of net loss deduction a corporation can take based on its income, and (2) if so, whether severance of the $3 million flat deduction cap is the appropriate remedy, rather than allowing an unlimited net loss deduction as did the Commonwealth Court.[9] In our order granting oral argument, we also directed the parties to further brief the effect, if any, of our Court's recent opinion in Mount Airy #1, LLC v. Pennsylvania Department of Revenue, 154 A.3d 268 (Pa. 2016) ("Mt. Airy"), which declared portions of the local tax assessment on casino revenue in the Gaming Act violative of the Uniformity Clause. Nextel v. Pennsylvania Department of Revenue, 6 EAP 2016 (Pa. filed Oct. 16, 2016) (order).

         II. Analysis

         A. Uniformity Clause Challenge

         The Department argues that the Commonwealth Court incorrectly held that the NLC violates the Uniformity Clause by erroneously measuring uniformity based on the effective corporate income tax rate, i.e., the actual rate of tax the corporate taxpayer paid on its income, [10] rather than the statutory corporate net income tax rate of 9.9%. The Department asserts that our Court has held that a corporate income tax statute does not violate the Uniformity Clause if it applies the same rate of taxation to the same tax base, even if certain income is excluded from that tax base for some corporations because of their individual circumstances. In support of this proposition, the Department relies on Turco Paint, supra (holding that, even though a Pennsylvania corporate excise tax calculated based on 3 factors - the corporation's gross receipts from Pennsylvania, its Pennsylvania payroll, and the physical property it owned in Pennsylvania - resulted in different tax liabilities for different corporations due to the fact these three factors were dissimilar for each corporation, this variance did not violate the Uniformity Clause, because the taxing statute imposed the same rate - 6% - on the same tax base for each corporation), and Warner Brothers, supra (holding that 10% excise tax applied to all corporations based on the corporation's net income under the federal tax code did not violate the Uniformity Clause, even though, under the federal tax code, the amount of capital deductions which a corporation could claim was limited and would vary from year to year, inasmuch as the tax base for all corporations was the same, and subject to the same 10% tax rate).[11] Thus, in the Department's view, these cases establish that, where, as here, a uniform tax rate is applied to the same tax base - which for a corporation it considers to be its net taxable income - there is no Uniformity Clause violation.

         The Department recognizes that our Court has found other types of taxes which exclude from their tax base varying amounts of property to be violative of the Uniformity Clause, because their operation resulted in members of the same class of taxpayers paying unequal amounts of taxes. Department Brief at 18-20 (citing Amidon v. Kane, 279 A.2d 53 (Pa. 1971) (personal income tax which was levied on a taxpayer's taxable income, as defined under the Internal Revenue Code, which resulted in individual taxpayers having various portions of their income exempted from taxation, violated the Uniformity Clause), and Clifton v. Allegheny County, 969 A.2d 1197 (Pa. 2009) (property tax assessment scheme that used an outdated base year valuation method, which undervalued some properties not reassessed since that base year, while assigning a higher market value to similar properties assessed after the base year, thereby resulting in the more recently assessed homeowners paying higher amounts of property taxes than those with base year assessments, contravened the Uniformity Clause)).

         However, the Department views those cases as distinguishable from the case at bar, contending that our Court, in Turco and Warner Brothers, has explicitly sanctioned the use of a different uniformity analysis with respect to corporate taxes, as opposed to income taxes, due to the way corporations operate. The Department notes that corporations are created for the purposes of producing profits, and deductions from corporate income, which are costs associated with producing that income, are applied first to establish the tax base before any uniformity analysis is conducted. The Department avers that, in those situations, the uniformity analysis merely considers whether the tax is imposed on that base at a fixed statutory rate, and, if so, the uniformity analysis comes to an end. However, the Department contends that individuals behave differently, and there is no necessity of determining their tax base by considering the costs of producing their income; rather, the deductions or exemptions are applied to compute the tax owed.

         The Department avers that the corporate income tax structure is also distinct from the estate tax at issue in Cope's Estate, as all corporate taxpayers pay the same rate, while in that case the tax at issue was what it characterizes as a "classically graduated" tax where the rate of taxation increased based on the value of an estate. Department Brief at 22. The Department also notes that a number of other taxes, such as excise or occupation taxes, have uniform tax rates for all taxpayers, yet, when applied, produce unequal tax burdens for taxpayers who pay them, because they produce an effective rate of taxation which varies by income, since people with lower incomes pay a greater proportion of their income as the result of these taxes. The Department contends that the effect of the Commonwealth Court decision calls into question the constitutionality of these taxes, as well as other income taxes that utilize deductions in the federal tax code as a basis to compute taxable income, which again results in a variable tax rate for taxpayers dependent on which deductions they claim.

         Alternatively, the Department argues that, even if the $3 million flat deduction implicates uniformity, it nevertheless is constitutional because the Uniformity Clause requires only substantial, not perfect, uniformity. The Department claims that, because only 234 out of 19, 537 corporations (1.2%) were unable to reduce their taxable income to $0 since their income was above $3 million, and because those corporations were still able to take a net loss deduction, the NLC deduction provision was "as nearly uniform as practicable, " and thus satisfied the constitutional requirement of "rough uniformity." Department Brief at 24.

         With respect to Mt. Airy, the Department argues that the issue in this case is fundamentally different from the question presented in that case, which concerned a challenge under the Uniformity Clause to the statutory tax rate, rather than a uniformity challenge to the calculation of the tax base, as in this case. Thus, the Department maintains that Mt. Airy did not address any issue involving a calculation of the tax base, noting that our Court specifically avoided opining on whether a uniformity violation could arise out of disparate effective tax rates. The Department also points out that our Court recognized in Mt. Airy that the Uniformity Clause allows "a bit more flexibility in the context of corporate taxation, " which the Department suggests counsels against finding a uniformity violation in this instance. Department Supplemental Brief at 7 (quoting Mount Airy, 154 A.3d at 277).[12]

         In response, Nextel maintains that, as the Commonwealth Court determined, the NLC violates the Uniformity Clause because it allows corporations with net loss carryover in excess of their 2007 income to deduct their losses without limitation if they have $3 million or less in taxable income, and thereby reduce their taxable income to $0, while limiting the amount of loss that corporations with over $3 million in taxable income may deduct, obligating those corporations to pay some income tax. Nextel notes that our Court has held tax laws which, although imposing a uniform rate of tax, provide "dollar-value thresholds for exemptions and deductions" from the tax, to be violative of the Uniformity Clause because they resulted in similarly situated taxpayers shouldering unequal burdens of taxation. Nextel Brief at 9-12 (citing Cope's Estate, supra, and Kelley v. Kalodner, 181 A. 598 (Pa. 1935) (personal income tax which provided for a flat exemption from taxation for single taxpayers with taxable income below $1, 000, and below $1, 500 for married taxpayers, violated the Uniformity Clause). Nextel asserts that the NLC's $3 million limitation operates the same as this type of dollar value threshold.

         Addressing the Department's contention that there is no Uniformity Clause violation because the same statutory rate of 9.9% is applied to the same tax base, Nextel disputes that the tax base - what it considers to be a corporation's taxable income - is the same for it and all other corporate taxpayers, because the $3 million limit on net loss carryover deductions led to it and 26 other corporate taxpayers having taxable incomes, whereas 19, 303 other corporate taxpayers with income falling under the $3 million limit and net loss carryovers in excess of their income had no taxable income.

         Nextel also disputes the Department's assertion that the NLC is constitutional under our holding in Turco Paint, reasoning that, under the taxing statute in that case, every corporate taxpayer was taxed on the same tax base, namely, the amount of its income which could be apportioned to Pennsylvania. Nextel also discounts the applicability of Warner Brothers on the grounds that the constitutional issue in that case was whether the legislature unconstitutionally delegated its taxing authority to Congress by using corporate net income as determined by the federal tax code, with all allowable deductions, as the tax base for the corporate income tax.

         Nextel proffers that our Court recognized in Amidon that, even though a taxing statute imposes a flat rate of taxation on income, it may nevertheless operate in a manner which causes a disparity in the effective tax rate paid by various groups of taxpayers subject to the tax, and that the difference in effective tax rates may trigger a Uniformity Clause violation. Nextel notes that, in Amidon, the personal income tax statute at issue in that case, which used taxable income as the tax base, defined such income in the same manner as the federal tax code that allowed various exemptions and deductions. Because the amount of a person's taxable income varied widely from taxpayer to taxpayer, depending on which deductions he or she elected to take because of his or her lifestyle, the effective rate of taxation he or she was subject to also varied widely, thereby violating uniformity. Nextel contends that the NLC likewise operates to subject it and the 26 other corporations which paid corporate income taxes to a higher effective rate of taxation - 8.74% - whereas 19, 303 other corporations paid an effective tax rate of 0%.

         Nextel also argues that the NLC deduction provision does not satisfy "rough uniformity" due to the disparity between its effective tax rate and the effective tax rate of the majority of other Pennsylvania corporations. Specifically, Nextel maintains that rough uniformity means that immaterial deviations are permitted, but asserts that the difference between a tax rate of 8.74% and a tax rate of zero cannot be considered an immaterial deviation.

         Regarding our Mt. Airy decision, Nextel asserts that its holding is directly applicable to this case, as Mt. Airy involved a tax which classified casinos based solely on the quantity of their receipts, inasmuch as casinos with receipts over $500 million paid a 2% tax, while casinos with receipts of $500 million or less paid a flat $10 million tax; Nextel avers this framework is similar to the tax in the instant case which classifies corporations based upon the quantity of their income. Nextel notes that, in Mt. Airy, our Court concluded that "such quantitative distinctions lack uniformity because any 'classification that is based solely on a difference in quantity . . . is necessarily unjust, arbitrary, and illegal.'" Nextel's Supplemental Brief at 6 (quoting Mt. Airy, 154 A.3d at 277). Nextel maintains that we should reach the same conclusion in this case, emphasizing that, although we have recognized that the Uniformity Clause allows more flexibility in the corporate context, we have never permitted tax classifications between corporations based on the quantity of their property.[13]

         Having discussed the arguments of the parties, we begin our analysis of this issue. The relevant constitutional provision at issue in this appeal - better known by its colloquial description, "the Uniformity Clause"- is Article 8, Section 1 of the Pennsylvania Constitution, which provides:

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.

Pa. Const. art. 8, § 1.

         This provision was part of a larger package of constitutional provisions the people of the Commonwealth approved in adopting the "Reform Constitution" of 1874 for the purpose of altering certain legislative practices which had become commonplace during the 19th century, but which, by the latter part of that century, had fallen into serious disfavor with the populace, who rightly perceived that these practices were intended to advance private or personal interests at the expense of the public's welfare.[14] Pennsylvania State Association of Jury Commissioners, 64 A.3d 611, 615 n.9 (Pa. 2013). The Uniformity Clause, the language of which has remained unchanged since its initial ratification by the voters, was a direct response to the legislative use of special tax laws applicable only to particular industries or individuals.[15] [16] Robert E. Woodside, Pennsylvania Constitutional Law 576 (1985).

         The use of such special tax laws in Pennsylvania to favor particular industries began in the early part of the 19th century as part of a broader effort underway at the time by many state governments to foster "internal improvements" within their borders, i.e., the construction of large physical transportation infrastructures such as canals, locks, dams, and ports on rivers to support the development of industries such as agriculture, coal mining, and timbering, and, later, as the Industrial Revolution came to America, iron and steel production. 1 Wade G. Newhouse, Constitutional Uniformity and Equality in State Taxation, 1731-32, 1735-37 (2d. ed. 1984). Although the Pennsylvania legislature directly financed many of these ventures for the benefit of private industries through bond issues which were repaid through tax dollars, it also provided indirect subsidies by bestowing upon these industries preferential tax treatment. Id. at 1203-04.

         Most notably, a primary beneficiary of support from our Commonwealth's public fisc was the railroad industry, which received generous assistance from the General Assembly through the appropriation of funds for the construction of railroad lines, and the direct award of charters to individuals for the creation and exclusive operation of railroad companies in certain geographic areas. Harold E. Cox and John F. Myers, The Philadelphia Traction Monopoly and The Pennsylvania Constitution of 1874: The Prostitution of an Ideal, Journal of Pennsylvania History vol. 35, no. 4, 1 (1968). By the era of the Civil War, the railroad companies had acquired such influence over the Pennsylvania legislature that they routinely obtained the passage of special legislation advancing their interests. The Railroad in Pennsylvania, Explore Pa. History, athttp://explorepahistory.com/story.php?storyId=1-9-10&chapter=1.[17] In the field of taxation, the railroads were particularly successful at securing special tax legislation through the efforts of their lobbyist Simon ...


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