On September 13, 2021, the Commonwealth Court held in Alcatel-Lucent USA Inc. v. Com., No. 803 F.R. 2017 (“Alcatel”), that the Pennsylvania Department of Revenue’s policy of applying the Pennsylvania Supreme Court’s landmark decision in Nextel Communications of the Mid-Atlantic, Inc. v. Com., 171 A.3d 682 (Pa. Oct. 18, 2017), only prospectively did not violate the state and federal constitutions.
Before 2017, the Commonwealth’s Corporate Net Income Tax statute had limited a taxpayer’s net operating loss deduction to the greater of a flat cap amount of the taxpayer’s taxable income or a percentage of the taxpayer’s apportioned income, both of which varied by year. For tax year 2007, the limit was the greater of 12.5% of taxable income or $3 million. In Nextel, the taxpayer argued that the statute discriminated against corporations with more than $3 million in taxable income (“large corporations”), because taxpayers with $3 million or less in taxable income (“small corporations”) paid no tax while large corporations could reduce their taxes by only 12.5%. The Supreme Court held that the flat cap violated the Uniformity Clause of the Pennsylvania Constitution but it preserved the percentage cap. Subsequently, the Department issued Corporation Tax Bulletin 2018-02, stating that it would not apply the Nextel decision to taxable years beginning prior to January 1, 2017.
In Alcatel, the taxpayer — who, in 2014, had applied the percentage cap and paid tax on its remaining income — sought a refund, arguing that the Department’s policy was unconstitutional because it continued to apply the percentage cap to large corporations before 2017 but not to the small corporations who had originally applied the now-unconstitutional flat cap. The taxpayer argued that it was therefore entitled to an unlimited deduction for 2014, just as the small corporations had effectively obtained.
According to the taxpayer, the Department’s policy violated the Uniformity Clause of the Pennsylvania Constitution because it systematically applied the percentage cap to large corporations but not to small ones. Thus, the question was whether the Department had been under a duty to retroactively apply Nextel to recalculate the deductions of small corporations under the percentage cap. The Commonwealth Court held that, under the three-pronged test of Chevron Oil Co. v. Huson, 404 U.S. 97 (1971), Nextel did not apply retroactively. Under that test, a court may apply a decision retroactively if: (1) the decision does not establish a new principle of law; (2) retroactive application will further the operation of the decision; and (3) the “relevant equities” are in favor of retroactive application. The Court agreed that, under the first prong, Nextel did not establish a new principal of law, because it had relied on long-standing legal precedent. But the Court concluded that, under the second prong, applying Nextel to retroactively remove the percentage cap on large corporations would not further that decision, which had explicitly upheld the percentage cap. The Court further concluded that, under the third prong, the prospect of “[r]etroactively assessing thousands of taxpayers that justifiably relied upon the legality of the flat-dollar deduction prior to the Nextel decision would produce a substantially inequitable result.” The Court distinguished its decision in General Motors Corp. v. Com., 222 A.3d 454 (Pa. Cmwlth. 2019), which had retroactively applied Nextel under the Chevron test, on the basis that the deduction for the tax year in that case (tax year 2001) was limited to the unconstitutional flat cap and not the percentage cap upheld in Nextel. Accordingly, the Court held the Department was not required to apply Nextel retroactively and therefore its policy did not violate the Uniformity Clause.
In addition, the Court held that the Department’s policy did not violate the federal Due Process Clause, which protects against the deprivation of property without due process of law, because the taxpayer had merely paid the correct tax due under the (constitutional) percentage cap and was therefore not deprived of property. The Court further held that the taxpayer did not suffer any discrimination prohibited under the federal Equal Protection Clause because the Supreme Court in Nextel had eliminated the relevant discrimination by removing the flat cap. Finally, the Court held that the taxpayer had received its “remedy by due course of law” as required by the Remedies Clause of the Pennsylvania Constitution because it had exercised its right to pursue its refund claim at the administrative boards and in the courts (despite the fact that the claim was ultimately unsuccessful).
If your company has received an assessment for Pennsylvania Corporate Net Income Tax or is pursuing a refund, please contact one of our state and local tax attorneys – Adam Koelsch (717-237-5305), Sharon Paxton (717-237-5393) or Paul Morcom (717-237-5364).