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Pennsylvania Tax Reports: "Personal Property Tax Unconstitutional; Remedy Uncertain"

Pennsylvania Tax Reports (June 5, 2000): "Personal Property Tax Unconstitutional; Remedy Uncertain"

June 5, 2000

by Joseph C. Bright
Wolf, Block, Schorr and Solis-Cohen LLP
Philadelphia, PA



Four years after the case was first brought, the Pennsylvania Supreme Court held that the imposition of Pennsylvania's Personal Property Tax by counties on shares of stock in foreign corporations that are not subject to Pennsylvania's Franchise tax, while not taxing shares of stock in other corporations, violates the Commerce Clause of the U.S. Constitution. The court left it up to the counties to determine what the remedy should be, but stated that the taxpayers were not entitled to refunds under a state refund statute. Annenberg v. Commonwealth, No. 03 M.D. Misc. Dkt. 1997 (Pa. June 1, 2000). Two justices dissented from the holding that refunds were not available under the state statute. The decision has dumped a major problem into the lap of the counties to determine appropriate relief, which may require action by the General Assembly to finally resolve.

In prior proceedings, the court held that the tax as applied was facially discriminatory, and directed the Court of Common Pleas of Montgomery County to determine whether the tax on foreign corporations was a valid compensatory tax. Annenberg v. Commonwealth, WL 156775 (Pa. April 7, 1998). The Montgomery County Court predictably concluded that the tax on foreign corporations was not a valid compensatory tax, and in this decision the Supreme Court agreed. The court examined the tax in light of the three criteria laid out in Fulton Corp. v. Faulkner, 516 U.S. 325 (1996), and found that the tax flunked all three, any one of which would have been fatal. The tax was not compensatory for taxes imposed under the Capital Stock or Franchise Taxes because the Personal Property Tax preceded the first Capital Stock Tax and the taxes were not part of a comprehensive system of taxation. Neither did the tax fairly relate to any services provided by Pennsylvania to corporations not doing business in Pennsylvania. The court reviewed the record and concluded that the tax burdens were not roughly equivalent. Finally, the Personal Property Taxes is not substantially equivalent to the Capital Stock and Franchise Taxes because the tax bases are not the same and they are imposed by different levels of government.

To cure the constitutional violation, the court held that the exclusion from the tax for domestic corporations and foreign corporations subject to the Franchise Tax must be stricken from the statute. The court rejected the argument that the tax as applied to the stock of all companies should be stricken. The court rejected the taxpayers' argument that the failure to enact a bill in 1996 to extend the tax to all stock was probative of the intention of the legislature that enacted the tax exclusion in 1889. Neither did the court accept the argument that striking the exclusion for foreign corporations, and thereby applying the statute to all stock, amounted to new tax legislation. The court stated that it was simply determining what the legislature would have done in 1889, when it added the exclusion, had it known that the exclusion for domestic corporations and corporations doing business here was unconstitutional. However, the court never stated why it concluded that in 1889 the legislature would have enacted the statute with no such exclusion. The court makes reference to the statutory requirement that a constitutionally offending provision shall not affect other parts of the statute unless the court finds that the valid provisions are so essentially and inseparably connected with and dependent upon the void provision that it cannot be presumed that the legislature would have enacted the remaining valid ones without the void one. 1 Pa. C.S. §1925. But the court offered no explanation how it concluded that the legislature would have enacted the tax with no such exclusion, as opposed to not taxing stock at all.

Turning to relief, the court noted the requirement of McKesson v. Division of Alcoholic Beverages and Tobacco, 496 U.S. 18 (1990), that a state must provide meaningful backward-looking relief to rectify an unconstitutional deprivation. Such relief could include refunds, the assessment and collection of back taxes from those who benefitted from an unlawful exemption, or a combination of both. The court rejected the argument that it had the power to apply only a prospective remedy, citing Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993), and Reynoldsville Casket Co. v. Hyde, 514 U.S. 749 (1995).

The court then held that the taxpayers were not entitled to refunds under a state statute providing a right of refund from a political subdivision for monies paid "to which the political subdivision is not legally entitled." 72 P.S. §5566(b). The court stated that because it had stricken the exclusion for domestic corporations and foreign corporations doing business here, there were no monies to which the counties imposing the tax were not entitled. Rather, the counties had granted other taxpayers unlawful exclusions.

The dissent found internally inconsistent the majority's holding that the tax was unconstitutionally discriminatory but that the counties did not unlawfully hold monies. The dissent seems to have the better part of the argument. No county has imposed the tax on shares of domestic corporations or foreign corporations doing business in Pennsylvania since 1889; therefore all counties in fact have discriminated against the stock of other foreign corporations. If every county discriminated, why are the moneys not then unlawfully held? At a minimum, the ruling may be premature. Whether the moneys are unlawfully held may depend on whether a county imposes the tax retroactively on heretofore excluded shares. If it does not, surely the tax moneys from nonexcluded shares are then unlawfully withheld.

Whether or not the dissent is correct, the counties generally, and Montgomery County in particular (the pertinent county in this appeal), are now charged with the responsibility of fashioning meaningful backward looking relief. Under McKesson, one option apparently is to impose the tax retroactively on stock in domestic corporations and foreign corporations doing business here. It is not clear whether that must be done by a new ordinance or simply by collecting tax from taxpayers who held such stock. In any event, imposing a new tax, or collecting the old one retroactively, may be politically and practically impossible. Annenberg was first brought in the Commonwealth Court in 1996. All counties since then have at some point suspended imposition or collection of the tax pending the outcome of Annenberg. Thus, tax on any intangible property -- whether stock, bonds or other property -- has not been collected for several years. Is it realistic to think that county taxpayers will permit their county commissioners to impose now several years of a tax that the taxpayers thought had been abandoned? Moreover, some taxpayers will have since left the county, and estate and trust taxpayers may have since distributed their assets. How are they to be treated under a retroactive tax? In any event, how far back must the counties go? The statute found inapplicable by the court provides a right of refund for payments made within three years of the claim. If that statute is not applicable, neither is its three year limit. Does the Constitution then require that the counties impose the tax back to 1889? Finally, as noted above, if a county elects not to impose the tax retroactively, and thereby confirms the discrimination, does that revive the state refund statute because the tax collected on stock of foreign corporations not subject to the Franchise Tax is now unlawfully held? If it does not, does the right of refund under McKesson extend back to 1889?

The court evidently has created a Serbonian bog of problems first by striking the exclusion as opposed to the application of the tax to all stock, and then by holding that the statute refund statute is inapplicable. Since the prospects for retroactive imposition of the tax seem dim, and the obligation to pay refunds may be virtually open-ended, it may take an act of the General Assembly to straighten matters out.

Taxpayers theoretically may have to consider applications for refund as far back as 100 years or more.