Pennsylvania court rules that Due Process requires retroactive application of net loss carryover relief

In brief

The Pennsylvania Commonwealth Court on December 28 ruled that a taxpayer was entitled to a refund of Pennsylvania net income taxes paid for the 2014 tax year. Based on the law as it existed in 2014, the taxpayer could not use all of its net loss carryovers because the state limited such carryovers to the greater of a percentage of apportioned income or a fixed-dollar limitation. A 2017 Pennsylvania Supreme Court decision struck down the fixed-dollar limitation as unconstitutional.  

Although the taxpayer paid tax based on application of the percentage limitation, the Commonwealth Court ruled that Due Process required that the taxpayer utilize its full net loss carryover without limitation.  

The takeaway: Unless the Commonwealth appeals the decision, taxpayers with pending claims now may be able to obtain refunds. Since the law was changed in 2017, the decision applies only to years prior to 2017, which generally would be closed under the three-year statute of limitations. Taxpayers amending returns due to a federal RAR should consider applicability of the case. 

[Alcatel-Lucent USA Inc. v. Commonwealth of Pennsylvania, Pa. Comm. Ct., No. 803 F.R. 2017 (12/28/22)] 

2017 Nextel decision 

In 2017, the Pennsylvania Supreme Court in Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth of Pennsylvania found that the NLC deduction, as applied to Nextel for the 2007 tax year, violated the Uniformity Clause of the Pennsylvania Constitution. For the 2007 tax year, the NLC deduction was limited to the greater of 12.5% of the taxpayer’s taxable income or $3 million. 

The Court concluded that the NLC deduction creates classes of taxpayers according to their taxable income. Taxpayers with taxable income in excess of $3 million could not reduce their corporate net income tax liability to zero, whereas similarly situated taxpayers with $3 million or less in taxable income could reduce their liability to zero. 

The Court sought to apply a remedy that it deemed would be most consistent with the legislature’s intent in enacting the NLC. The Court determined that striking down the fixed-dollar limitation, while retaining the percentage limitation, would be most consistent with the legislature’s intent to have the NLC balance the twin policy objectives of encouraging investment and maintaining the Commonwealth’s financial health. Click here for our Insight regarding Nextel. 

The Department implemented Nextel prospectively by removing the flat-dollar limitation beginning in 2017 and thereafter. 

Due Process violation requires retroactive relief 

Alcatel-Lucent argued that the General Motors decision holds that Nextel applies retroactively to all years. The Commonwealth Court agreed. In order to cure the Due Process violation, the court awarded Alcatel-Lucent a refund. 

The court found that Alcatel-Lucent was entitled to an uncapped NLC deduction based on Due Process, recognizing that “the right to uniform taxation is a right protected by the Due Process Clause.”  As stated by the court:  

“in the 2014 Tax Year, the small corporate taxpayers benefited from the NLC’s flat-dollar deduction, which was declared unconstitutional. Small corporate taxpayers were favored while large corporate taxpayers with incomes greater than $4,000,000 were disfavored under the statutory scheme. Even though Taxpayer correctly paid its taxes in conformity with the retained and constitutionally valid percentage cap, Taxpayer was disadvantaged when compared to small corporate taxpayers that utilized the unconstitutional flat-dollar deduction and paid no tax. To equalize the actual tax positions. . . either the favored taxpayers be assessed additional taxes or the unfavored taxpayer be refunded the taxes it paid. Because a retroactive reassessment of favored taxpayers’ tax liability is foreclosed under the statute of limitations, replete with inequities, the only remedy available is to issue Taxpayer a refund to remedy the Uniformity Clause violation to equalize the tax positions between favored and nonfavored taxpayers.”