By Patrick K. Skeehan, JD

In December 2022, the Pennsylvania Commonwealth Court ruled in Alcatel-Lucent v. Commonwealth that a corporate taxpayer was entitled to a refund of corporate net income tax (CNIT) that was paid for the 2014 tax year when the use of net loss carryovers (NLC) was limited by Pennsylvania’s percentage limitation for net loss deductions.¹ In reviewing exceptions filed by the taxpayer, an en banc court reversed an earlier panel decision in light of a 2021 Pennsylvania Supreme Court decision ruling that its landmark 2017 Nextel Communications² decision applies retroactively and that due process requires equalizing the tax positions of favored and disfavored taxpayers.  

As the latest decision in a long line of Pennsylvania net loss deduction cases, Alcatel-Lucent illustrates the challenges of arriving at a feasible and appropriate taxpayer remedy following the Department of Revenue's (DOR's) application of the Nextel decision, which struck down the fixed-dollar limitation of Pennsylvania’s net loss deduction provision.  

Background

Alcatel-Lucent carried forward about $791 million of net losses into the 2014 tax year. During this year, the company had taxable income apportioned to Pennsylvania of about $27 million before any net loss deductions. In 2014, Pennsylvania’s NLC deduction limitation was the greater of 25% of taxable income or $4 million.³ Using the percentage limitation, Alcatel-Lucent took a net loss deduction of approximately $6.8 million, resulting in a CNIT liability of about $2 million. The company later sought a refund of tax paid, arguing that Pennsylvania’s NLC deduction provision violated the uniformity clause of the Pennsylvania Constitution because the company owed tax while other smaller taxpayers did not.

In 2017, during the appeal of Alcatel-Lucent’s case, the Pennsylvania Supreme Court decided Nextel, holding that the fixed-dollar portion of Pennsylvania’s NLC provision violated Pennsylvania’s uniformity clause because some taxpayers could eliminate their CNIT liability while similarly situated taxpayers were required to pay tax. In fashioning a remedy, the court severed the fixed-dollar limitation from the NLC provision while preserving the percentage limitation. This remedy left Nextel in the same financial position because it was still subject to the percentage limitation. In response to Nextel, the DOR clarified that it would apply Nextel on a prospective basis, meaning that it would not reassess corporations that used the fixed-dollar limitation prior to the 2017 tax year.⁴

In September 2021, a Commonwealth Court panel determined that Alcatel-Lucent was not entitled to a refund of CNIT paid when use of NLCs was limited by the percentage limitation. In denying the refund, the panel found that Nextel does 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 Pennsylvania’s uniformity principles or the due process clause of the U.S. Constitution.

Three months later, in General Motors Corp. v. Commonwealth, the Pennsylvania Supreme Court applied Nextel retroactively, holding that Pennsylvania’s $2 million fixed-dollar limitation as it existed in 2001 also violated uniformity principles.⁵ Notably, unlike in Nextel and Alcatel-Lucent, the NLC deduction provision at issue in General Motors contained only the fixed-dollar limitation during pre-2007 tax years. To remedy the uniformity violation, the court struck down the NLC deduction statute in its entirety as applied to General Motors during the 2001 tax year. Additionally, the court found that the due process clause requires “meaningful backward-looking relief” to put disfavored taxpayers in the same position as favored taxpayers.⁶ As a remedy to the due process violation, the court required General Motors to receive a full refund for the tax paid as a result of the NLC deduction limitation.  

Commonwealth Court Decision

After General Motors, Alcatel-Lucent asked 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. In granting the refund, the court noted that it was constrained by the Pennsylvania Supreme Court’s decision to find that Nextel applies retroactively. The court noted, however, that Alcatel-Lucent correctly paid tax in conformity with the percentage limitation, which was upheld in Nextel.

The court further acknowledged that the due process analysis used in General Motors also applied in the Alcatel-Lucent case, noting the requirement that the positions of all taxpayers be equalized. Specific to the 2014 tax year, the court noted that more than 13,000 corporate taxpayers paid no tax because their income did not exceed the fixed-dollar limitation and they cannot be reassessed because the tax year is closed under the statute of limitations. Therefore, the court concluded, “the only way to equalize the position of Taxpayer with favored taxpayers is to allow Taxpayer a full net loss deduction, like the other taxpayers enjoyed.”

Based on the General Motors decision and the application of U.S. Supreme Court case law, Commonwealth Court concluded that Alcatel-Lucent was entitled to a refund under due process principles and remanded the case to the Board of Finance and Revenue to issue a refund. On Jan. 18, 2023, the commonwealth appealed the decision to the Pennsylvania Supreme Court, taking exception to Commonwealth Court’s conclusion that Nextel applies retroactively to all tax years. Because the appeal is as-of-right, the Pennsylvania Supreme Court is required to accept the appeal and hear the case.

Implications

At first glance, the Alcatel-Lucent decision may be thought to have limited application to corporate taxpayers due to the tax years implicated in the decision. Since Nextel was decided in 2017 and the NLC deduction statute contains only a percentage limitation beginning in that tax year, Alcatel-Lucent applies only to tax years prior to 2017, which would generally be closed under the state’s three-year statute of limitations. Should the Pennsylvania Supreme Court uphold the Commonwealth Court’s decision on appeal, taxpayers may benefit from the decision if they filed protective refund claims or the statute of limitations is otherwise open under audit or appeal.

Taking a broader view, the decision illustrates the challenges faced by Pennsylvania courts in applying the Nextel decision to particular tax years. At the most basic level, the decision merely applies the Pennsylvania Supreme Court’s decision in General Motors, which established that Nextel should be applied retroactively to pre-2007 tax years when the percentage limitation was not in place, and that a refund would best remedy the due process violation of taxpayer rights under U.S. Supreme Court case law. However, Alcatel-Lucent adds another wrinkle to the equation in that the taxpayer correctly paid CNIT in 2014 using the percentage limitation, but subsequently requested a refund following Nextel, although the percentage limitation was ultimately upheld in Nextel. Ultimately, the Commonwealth Court’s decision to grant the refund results from the DOR’s administrative decision not to apply the Nextel decision to pre-2017 tax years. Had DOR applied Nextel to the open years, it most likely would have avoided the due process violation subsequently raised in Alcatel-Lucent. 

Although the Commonwealth Court denied Alcatel-Lucent’s refund in its first decision, the General Motors decision allowed Alcatel-Lucent to challenge the first decision and make the due process arguments in favor of equalizing its position relevant to other taxpayers who paid no CNIT during the 2014 tax year. For now, Alcatel-Lucent confirms that the General Motors due process analysis may be extended to apply to the use of NLCs from the 2007 through 2016 tax years in which both the fixed-dollar cap and percentage limitation were in effect. However, the final disposition of the case depends on whether the Pennsylvania Supreme Court agrees with the relief prescribed by Commonwealth Court.

¹ Alcatel-Lucent USA Inc. v. Commonwealth, No. 803 F.R. 2017, Pa. Commonwealth Court, Dec. 28, 2022.
² Nextel Communications of the Mid-Atlantic v. Commonwealth, 171 A.3d 682 (Pa. 2017).
³ 72 Pa. Stat. Section 7401(3)4.(c)(1)(A)(V).
⁴ Corporation Tax Bulletin 2018-02, Net Operating Loss (NOL) Deduction Application of Nextel Communications v. Commonwealth, Pennsylvania Department of Revenue, May 10, 2018.
⁵ General Motors Corp. v. Commonwealth, 265 A.3d 353 (Pa. 2021).
⁶ Quoting McKesson v. Florida Division of Alcoholic Beverages, 496 U.S. 18 (1990).

Patrick K. Skeehan, JD, is a state and local tax senior manager in Grant Thornton LLP’s Washington National Tax Office based in Philadelphia. He can be reached at patrick.skeehan@us.gt.com.

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