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Would a Sprint Nextel subsidiary alone benefit if the Pennsylvania Supreme Court invalidates the state’s cap on carryover of net operating losses, or would thousands of taxpayers also get refunds?
Such questions surround a case involving Nextel Communications of the Mid-Atlantic Inc. and dominated the discussion April 5 during oral arguments before the Pennsylvania Supreme Court ( Nextel Commc’ns of the Mid-Atlantic, Inc. v. Commonwealth, Pa., No. 6 EAP 2016, oral arguments 4/5/17 ).
Nextel asked the court to uphold a November 2015 decision by the Commonwealth Court, which unanimously declared that Pennsylvania’s cap on the carryover of prior-year losses violated the uniformity clause of the state’s constitution and ordered a $3.9 million refund for the company. Pennsylvania, appealing the decision, argued that the lower court erred by ignoring decades of case law, that corporate taxpayers may be treated differently than individuals, that there was no uniformity violation, and that a finding in favor of Nextel would “fundamentally” change how the law is applied.
“I’m interested in the potential repercussions,” Justice Christine Donohue said, calling the case “a conundrum.”
The case matters to thousands of corporate taxpayers in Pennsylvania that take advantage of the state’s deduction on net operating losses. Since 2006, Pennsylvania has allowed companies to take the deduction, but caps the amount that companies can carry over from one year to the next. The effective result: companies with the largest incomes pay tax while others don’t. If the cap is declared unconstitutional, taxpayers could see their taxes go up or down, depending on what remedy the court chooses.
The current cap is $5 million or 30 percent of taxable income, whichever is larger.
“This is your steepest challenge,” Justice Max Baer told John Bartley Delone, who represented the commonwealth. In 2007, the year in question, the cap was $3 million or 12.5 percent of income.
“If the taxpayer earns $3 million or less, they pay zero,” he said. “It’s that cliff that seems to run afoul of uniformity.”
The Uniformity Clause of the Pennsylvania Constitution says that 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.”
In 2007, a total of 19,537 companies in Pennsylvania had net loss carryovers. Virtually all of them, or 19,303 companies, had income of less than $3 million and were thus able to reduce their taxable income to zero. Only 1.2 percent of the total—just 234 companies—had income of more than $3 million. Among them was Nextel, which was limited to a $5.6 million deduction despite carrying more than $150 million in losses due to its $45 million of taxable income that year.
Delone argued that if the court found in favor of Nextel, it would effectively be declaring the existing statute unconstitutional. He said that more than 80 years of case law found reason to treat corporate taxpayers differently from individuals, because corporations “are rational and maximize taxes,” while individuals usually don’t.
Nextel’s attorney, Kyle O. Sollie of Reed Smith LLP, argued that the court should focus on the particular circumstances involving Nextel in 2007 and that the decision didn’t necessarily need to involve other taxpayers in other years.
Baer appeared to question how a ruling in favor of Nextel couldn’t be applied to other taxpayers. “Does Ms. Roe get to say: ‘I get to do what I want with my body but nobody else does?’” he asked.
The court also grappled with what remedy to choose if it found a constitutional violation.
The Commonwealth Court split 5-2 on how to solve the constitutional problem. The majority opinion, written by Judge P. Kevin Brobson, said the limitation on net operating losses should be removed entirely. A dissent written by President Judge Dan Pellegrini argued that the flat dollar cap should be eliminated and the percentage cap should be applied to all taxpayers.
Justice David N. Wecht wondered if removing the 20-year limit on the claiming the deduction would eliminate the constitutional problem. Caps can be carried over for 20 years, but if losses are large, they may expire before they can be used.
The “irony” is that if the court decides that the cap is unconstitutional and as a remedy chooses to eliminate the $3 million cap while keeping the 12.5 percent in place, Nextel would see no benefit, Baer told Sollie. “There’s no recognition or correction of an unconstitutional tax.”
Yet it would be illogical if the court kept the 12.5 percent limit while also giving Nextel a refund, Baer suggested. “We can’t say, ‘you win and you don’t pay tax,’” Baer said. “We can’t carve you out for special treatment.”
Wecht said there was precedent for decisions in which a litigant wins without receiving any benefit. “You would acknowledge there’s case law out there,” Wecht told Sollie, where “some heroic litigant secures relief” for others “and reaps no benefit whatsoever for himself.”
The court didn’t give a timetable for a decision.
To contact the reporter on this story: Leslie A. Pappas in Pittsburgh at LPappas@bna.com
To contact the editor responsible for this story: Ryan C. Tuck at email@example.com
Text of the commonwealth's brief is at http://src.bna.com/nGR.
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