Pennsylvania denies CNIT refund related to NOL limitation

 

On Nov. 20, 2024, the Pennsylvania Supreme Court (Court) ruled that a taxpayer was not entitled to a refund of corporate net income tax (CNIT) paid for the 2014 tax year when the taxpayer’s use of net loss carryovers (NLCs) was limited by the state’s percentage limitation for net loss deductions.1 In reversing the Pennsylvania Commonwealth Court, the Court determined that its own decision in General Motors (GM)2 was incorrectly decided, meaning that its landmark Nextel decision3 striking down the fixed-dollar limitation on NLC deductions does not apply retroactively to pre-2017 tax years. Finding that GM was erroneous, the Court held that the Nextel decision should be applied on a prospective basis only and that due process does not require the Commonwealth to refund the CNIT paid by the taxpayer.

 

 

 

Background and procedural history

 

Alcatel-Lucent USA Inc. (Alcatel-Lucent), a corporation providing IP networking, broadband access and cloud technology services, carried forward approximately $791 million in net losses into the 2014 tax year. In 2014, the taxpayer had taxable income apportioned to Pennsylvania of approximately $27 million before net loss deductions.

 

Historically, Pennsylvania has allowed for an NLC deduction that can best be described as complex, restrictive, and inconsistent. With respect to the restrictions to the NLC deduction, Pennsylvania has applied at least one of two separate limitations: (i) a limitation based on a percentage of taxable income reported by the taxpayer (the percentage limitation) and/or (ii) a limitation based on a flat amount of income reported by the taxpayer (the fixed-dollar limitation). During the 2014 tax year, Pennsylvania’s NLC deduction limitation was the greater of 25% of taxable income or $4 million.4

 

Using the percentage limitation, Alcatel-Lucent took a net loss deduction of approximately $6.8 million, ultimately resulting in a CNIT liability of approximately $2 million. The taxpayer later sought a refund of tax paid, arguing that Pennsylvania’s NLC deduction provision violated the Uniformity Clause of the Pennsylvania Constitution5 because the company still owed tax after application of the NLC deduction, while other taxpayers utilizing the $4 million NLC fixed-dollar limitation did not.

 

 

The Nextel decision

 

In 2017, during the appeal of Alcatel-Lucent’s case, the Court decided Nextel, holding that the fixed-dollar limitation portion of Pennsylvania’s NLC deduction provision as it applied in 2007 violated the Pennsylvania Uniformity Clause because some taxpayers could eliminate their CNIT liability while similarly situated taxpayers were required to pay tax. In deciding on a remedy, the Court determined that severing the fixed-dollar limitation from the NLC provision while retaining the percentage limitation satisfied the twin policy objectives of the statute: encouraging business investment and maintaining the Commonwealth’s fiscal health. In response to Nextel, the Pennsylvania Department of Revenue (Department) decided that it would apply Nextel on a prospective basis only, meaning that it did not apply the fixed-dollar limitation beginning in the 2017 tax year and beyond, and would not assess corporate taxpayers utilizing the fixed-dollar limitation prior to the 2017 tax year.6

 

 

Initial Commonwealth Court decision

 

In September 2021, a Commonwealth Court panel determined that Alcatel-Lucent was not entitled to a refund of CNIT paid when the company’s use of NLCs was limited by the percentage limitation.7 In denying the refund, the panel found that Nextel did not require a retroactive elimination of the percentage limitation based on the taxpayer’s income. Instead, the panel ruled that prospective application of Nextel did not violate the Commonwealth’s uniformity principles or the Due Process Clause of the U.S. Constitution.

 

 

The General Motors decision

 

Three months later in the GM case, the Court applied Nextel on a retroactive basis in severing the Commonwealth’s entire NLC deduction as applied to the 2001 tax year.8 Unlike in Nextel and Alcatel-Lucent, the NLC deduction provision at issue in GM contained only a $2 million fixed-dollar limitation in the 2001 tax year. To remedy the uniformity violation, the Court struck down the NLC deduction in its entirety. Following U.S. Supreme Court case law, the Court reasoned that the Nextel decision did not establish a new principle of law, and instead merely drew upon other court decisions interpreting the Uniformity Clause in the same way.9 The Court likewise found that the Due Process Clause requires “meaningful backward-looking relief” to put disadvantaged taxpayers in the same position as taxpayers that were able to completely offset their CNIT liability using the fixed-dollar limitation.10 To remedy the due process violation, the Court required that GM receive a full refund of tax paid resulting from the NLC deduction limitation.

 

 

Second Commonwealth Court decision

 

After the GM decision, Alcatel-Lucent asked an en banc panel of the Commonwealth Court to reconsider its initial decision that the company was not entitled to a $2 million refund after the Department declined to retroactively apply Nextel. The court considered whether GM applied to pre-2017 tax years under which the percentage limitation of the NLC provision was still in place. In reversing its previous decision, the court noted that it was constrained by the Court’s GM decision finding that Nextel applied retroactively.11 The court acknowledged that the due process analysis used in GM also applied in this case, noting the requirement that the tax positions of all taxpayers be equalized. Accordingly, the court concluded that Alcatel-Lucent was entitled to a refund under the reasoning of GM.

 

In January 2023, the Commonwealth appealed the decision to the Court, taking exception to the Commonwealth Court’s decision that Nextel applies on a retroactive basis. Specifically, the Commonwealth argued that the Commonwealth Court erred in applying GM, and that GM should be overturned. The Court heard oral arguments in this case in March 2024.

 

 

 

Supreme Court decision

 

In a 4-3 decision, the Court agreed with the Commonwealth that GM was incorrectly decided. In reaching this conclusion, the Court determined that it had improperly applied the three-part test set out in the U.S. Supreme Court’s decision in Chevron Oil Company v. Huson in determining that the Nextel decision applied retroactively, in part because the Court failed to analyze all three factors.12 Under the Chevron retroactivity test, courts must consider: (i) whether the decision established a new principle of law; (ii) whether retroactive application of the decision would advance or thwart the operation of the decision; and (iii) whether the relevant equities favor prospective application. The Court noted that the GM majority addressed only the first factor, even though case law has established that the third factor “is often the most important one.”

 

Starting with the first factor of the Chevron retroactivity test, the Court concluded that the GM court wrongly concluded that Nextel did not establish a new principle of law. The Court found that previous Court decisions on individual income tax matters announced broad principles supporting the argument that the fixed-dollar limitation violated uniformity, while other decisions suggested that corporate income tax decisions would be subject to a more liberal analysis regarding uniformity violations than individual income taxes. Based on this distinctly different analysis dependent upon tax type, the Court determined that Nextel presented an issue of first impression.

 

Moving to the second factor, the Court found that retroactivity is unnecessary to further operation of the rule announced in Nextel. The Court noted that even under a retroactive approach, refunds would only be available to those taxpayers that sought refunds within the statute of limitations. Acknowledging that there are inequities associated with prospective application of Nextel, those inequities are inevitable “given that the General Assembly consistently has opted to use a capped NLC deduction since 1994.”

 

Turning to the third Chevron factor, the Court reasoned that the balance of the equities “clearly weigh in favor of prospective-only application of Nextel.” The Court referenced case law announcing that the invalidation of a tax statute does not apply retroactively.13 While the general rule may be overcome, the Court found there was no showing that refunding the taxes would not result in harm from a revenue perspective. In fact, the Court noted that while it doesn’t know exactly, retroactive application of Nextel would require hundreds of millions of dollars in tax revenue to be refunded.

 

Finally, the Court also disagreed with the GM court’s holding that due process requires the equalization of positions of the taxpayers benefitting from the fixed dollar cap on NLC deductions with those that were harmed by it. Finding that Nextel does not apply retroactively, the Court held that backward-looking relief is not required to be awarded in this case. Accordingly, the Court reversed the en banc decision of the Commonwealth Court.

 

 

 

Concurring and dissenting opinions

 

Four justices filed separate opinions, with two filing concurring opinions, one filing a concurring and dissenting opinion, and one filing a dissenting opinion. The first concurring justice wrote separately to note that the taxpayer in Nextel was not due a refund because it had paid the correct amount of tax under the upheld portions of the NLC provision. The justice noted that a retroactive application of GM would have meant that General Motors paid too little in taxes as a result of severing the NLC deduction entirely. In the justice’s view, awarding a refund under a due process reasoning had the effect of superseding the retroactivity issue in that case.

 

A second concurring justice wrote separately to note that state law, not federal law, controls whether a state court decision applying state constitutional protections applies on a retroactive basis, but agreed with the result that Alcatel-Lucent was not entitled to a refund because it did not overpay its 2014 taxes. The opinion suggested that the state legislature provide some form of bounty or the court could allow the parties to recover attorney fees to help incentivize “the important public service” of holding the government accountable under the state constitution.

 

In a concurring and dissenting opinion, one justice agreed with the majority that Nextel applies on a prospective basis but maintained that it was unnecessary to overrule GM since the case concerned the fixed-dollar limitation rather than the percentage limitation. The justice would have retained GM’s rationale and chosen remedy to pending uniformity challenges brought to NLC provisions providing only a fixed-dollar limitation deduction.

 

In a dissenting opinion, another justice disagreed with the Court’s decision to deny the refund, contending that Alcatel-Lucent is entitled to some form relief for the constitutional harm suffered, in addition to taxpayers with similar and pending refund claims relating to the 2014 NLC deduction limitation. The justice suggested that the Court could “fashion another form of relief,” such as partial refunds or credits, that would “remedy the constitutional wrong and temper the impact on government budgets” in the case that a full refund would be harmful to the Commonwealth.

 

 

 

Commentary

 

The Alcatel-Lucent decision is the latest in a long line of uniformity cases considered by Pennsylvania courts, which have historically applied a strict interpretation of the Commonwealth’s uniformity clause. Specifically, the case represents the third significant Pennsylvania Supreme Court decision ruling on the application of the Commonwealth’s controversial NLC deduction provision, which began with the Court striking down the fixed-dollar limitation in Nextel in 2017. The issue that has long vexed the courts has been the appropriate taxpayer remedy based on the structure of the NLC deduction provision for the tax year at issue. The issue of whether to apply retroactive relief stems in large part from the Department’s decision not to apply the Nextel decision to pre-2017 tax years.

 

In Alcatel-Lucent, the taxpayer paid tax in 2014 using the percentage limitation, which was not available to taxpayers in GM and was ultimately retained in Nextel. In GM, the Court decided that Nextel should be applied retroactively in order to remedy the due process violation, meaning that it had to strike down the entire NLC deduction provision as applied to the 2001 tax year and provide the taxpayer a full refund of tax paid. Only three years later, the Court determined that GM was incorrectly decided in declining to provide the same retroactive relief to Alcatel-Lucent.

 

At first glance, the holding of Alcatel-Lucent may be thought to have limited application, given that it applies to pre-2017 tax years implicated by the Nextel decision. Those years are generally closed under the Commonwealth’s three-year statute of limitations unless taxpayers filed protective refund claims for those years. More broadly speaking, the decision means that it may be more difficult for taxpayers to request retroactive relief for tax types presenting uniformity violations if the result will negatively impact the Commonwealth’s revenues. Unlike in GM, the Court appeared more persuaded by arguments concerning the revenue impact to the Commonwealth as a result of applying Nextel retroactively and issuing refunds to similarly situated taxpayers with pending refund claims.

 

Perhaps because the complexity of the NLC deduction has resulted in lingering litigation and a badly split Court in this most recent decision, Alcatel-Lucent has made a motion to reargue the case.14 The taxpayer’s motion requests that the case be remanded to Commonwealth Court for further factual development, and that federal due process considerations require the Court to provide the taxpayer with an opportunity to develop the factual record in relation to the second and third factors of the Chevron retroactivity test. In addition, the taxpayer is requesting that since this case is changing the law by reversing GM, and hence, the law of retroactivity, this change should be applied only on a prospective basis. Finally, since there was no change in the rule of law in this case, federal due process requires a remedy. One would expect the Department to file a motion in opposition, at which point the Court could decide whether the jurisprudence regarding the NLC deduction and retroactivity challenges is essentially complete, or whether these issues will remain unsettled for the foreseeable future.

 

 


1 Alcatel-Lucent USA Inc. v. Commonwealth, Pennsylvania Supreme Court No. J-20-2024, Nov. 20, 2024.
2 General Motors Corp. v. Commonwealth, 265 A.3d 353 (Pa. 2021).
3 Nextel Communications of the Mid-Atlantic, Inc. v. Commonwealth, 171 A.3d 682 (Pa. 2017).
4 72 PA. STAT. § 7401(3)4.(c)(1)(A)(V).
5 Pennsylvania’s Uniformity Clause requires that “[a]ll taxes shall be uniform, upon the same class of subjects, within the territorial limits of the authority levying the tax.” PA. CONST. art. VIII, § 1.
6 Corporation Tax Bulletin 2018-02, Net Operating Loss (NOL) Deduction Application of Nextel Communications v. Commonwealth, Pennsylvania Department of Revenue, May 10, 2018.
7 Alcatel-Lucent USA Inc. v. Commonwealth, 264 A.3d 826 (Pa. Commw. Ct. 2021). For further discussion, see GT SALT Alert: Pennsylvania denies refund related to NLC limitation.
8 For further discussion of the GM decision, see GT SALT Alert: Pennsylvania severs net loss carryover provision.
9 Citing Chevron Oil Co. v. Huson, 404 U.S 97 (1971).
10 Quoting McKesson v. Florida Division of Alcoholic Beverages, 496 U.S. 18 (1990).
11 Alcatel-Lucent USA Inc. v. Commonwealth, 290 A.3d 1285 (Pa. Commw. Ct. 2022). For further discussion, see GT SALT Alert: Pennsylvania grants relief on net loss provision.
12 404 U.S. 97 (1971).
13 Citing Oz Gas, Ltd. v. Warren Area School District, 938 A.2d 274 (Pa. 2007).
14 The taxpayer submitted its motion for reargument on Dec. 4, 2024.

 

 
 

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