            IN THE COMMONWEALTH COURT OF PENNSYLVANIA


RB Alden Corp.,                              :
                       Petitioner            :
                                             :
               v.                            : No. 73 F.R. 2011
                                             : Argued: May 12, 2016
Commonwealth of Pennsylvania,                :
                Respondent                   :


BEFORE:        HONORABLE RENÉE COHN JUBELIRER, Judge
               HONORABLE PATRICIA A. McCULLOUGH, Judge
               HONORABLE DAN PELLEGRINI, Senior Judge


OPINION BY
SENIOR JUDGE PELLEGRINI                                      FILED: June 15, 2016


               This is a petition for review from an order of the Board of Finance and
Revenue (Board) in which RB Alden Corporation (Taxpayer) claims that it owes
no Pennsylvania corporate income tax on a $29.9 million capital gain profit
resulting from the sale of part of a partnership interest. Taxpayer makes that claim
on a number of alternative bases contending that:

                     gain from a sale of the partnership interest is
               “nonbusiness income” under Section 401(3)2.(a)(1)(D)
               of the Tax Reform Code of 1971 (Code),1 not “business
               income” under Section 401(3)2.(a)(1)(A) of the Code;2



      1
          Act of March 4, 1971, P.L. 6, No. 2, as amended, 72 P.S. §7401(3)2.(a)(1)(D).

      2
          72 P.S. §7401(3)2.(a)(1)(A).
                  the gain must be excluded from its apportionable
            tax base under the doctrines of multiformity or unrelated
            assets;

                  the gross proceeds from the sale of the partnership
            interest should be sourced to New York, the state in
            which it is headquartered, for purposes of calculating the
            sales factor of its corporate net income tax apportionment
            fraction, rather than Pennsylvania, where the property
            from which the sale is derived is located;

                 under the tax benefit rule, it is entitled to exclude
            from business income the gain from the sale because it
            had previously taken a deduction for which it received no
            benefit; and

                under Nextel Communications of Mid-Atlantic, Inc.
            v. Commonwealth of Pennsylvania, 129 A.3d 1 (Pa.
            Cmwlth. 2015), limiting its net loss carryover deduction
            to $2 million violates the Uniformity Clause of the
            Pennsylvania Constitution, Pa. Const. art. VIII, §1.


We will address each of those issues.


                                        I.
                                        A.
            According to the parties’ Stipulation of Facts, Taxpayer is a Delaware
corporation. During the tax year beginning July 1, 2006, and ending June 30, 2007
(Fiscal Year 2006), Taxpayer was wholly owned by Riverbank Properties, Inc.
(Riverbank), and Riverbank was wholly owned by RB Asset, Inc. (RB Asset).
Accordingly, during Fiscal Year 2006, Taxpayer was indirectly wholly owned by
RB Asset.




                                        2
               At the beginning of Fiscal Year 2006, Taxpayer was the sole general
partner and owned 87.36% of the limited partnership interest of Eastview
Associates LP (Partnership). The Partnership was formed as a New Jersey general
partnership in 1984, and in 1989, it converted into a New Jersey limited
partnership.


               The Partnership owned an apartment complex in Philadelphia known
as Alden Park Apartments (Apartment Complex). Prior to 1995, the Partnership
borrowed $40 million from National Westminster Bank USA (National
Westminster).     In connection with the loan, National Westminster obtained a
mortgage securing the loan (the mortgage and loan hereinafter collectively referred
to as the “Secured Loan”). In January 1995, National Westminster merged with
and into National Westminster Bank NJ, which subsequently changed its name to
NatWest Bank National Association (NatWest). In March 1995, NatWest sold the
Secured Loan to Hampton Ponds, a subsidiary of River Bank America. In May
1998, River Bank America completed a reorganization into RB Assets under which
RB Assets assumed all River Bank America’s assets and liabilities, including River
Bank America’s interest in the Secured Loan.


               After the Partnership defaulted on the Secured Loan, Taxpayer
acquired its general and limited partnership interest in the Partnership as a result of
restructuring to give its lender control of the Partnership. As the sole general
partner of the Partnership, Taxpayer’s only business activity was operating and
controlling the Partnership’s operations, including those of the Apartment
Complex.



                                          3
            Beginning in 1989 and continuing through Fiscal Year 2006, the
Partnership incurred and reported a taxable loss from operations which was passed
through pro-rata to Taxpayer. Taxpayer filed federal income tax returns for each
tax year from 1989 through Fiscal Year 2006 and reported its share of the
Partnership’s operational losses. Likewise, Taxpayer filed Pennsylvania corporate
tax reports for each tax year from 1989 through Fiscal Year 2006 and reported
100% of its share of the Partnership’s operational losses as business income.
Taxpayer did not file an income tax return in any state other than Pennsylvania and
never apportioned any of its Pennsylvania taxable income or loss for any tax year.
Taxpayer was unable to use its share of the Partnership’s losses to reduce
Pennsylvania taxable income during the tax years prior to Fiscal Year 2006 as
neither Taxpayer nor the Partnership generated any Pennsylvania taxable income
during those years.


            Taxpayer’s assets during Fiscal Year 2006 consisted of its general and
limited partnership interests in the Partnership and certain intercompany
receivables owed to it by the Partnership. That year, pursuant to an Assignment,
Assumption and Substitution Agreement (Agreement) dated June 27, 2007,
Taxpayer sold a 45% limited partnership interest in the Partnership to PCK Capital,
Inc. (Buyer).    In exchange for the transferred partnership interest, Buyer
transferred $5,000 cash to Taxpayer and assumed $29.9 million of the
Partnership’s nonrecourse liabilities attributable to the transferred partnership
interest. Taxpayer retained a 42.36% limited partnership interest and a 1% general
partnership interest in the Partnership and continued to operate and control the
Partnership and the Apartment Complex as before.



                                        4
                In March 2008, Taxpayer filed its 2006 Pennsylvania corporate tax
report and 2006 Proforma federal return.3              The 2006 Proforma federal return
reflected a federal taxable income of $24.5 million, which includes a $29.9 million
gain on the sale of the transferred partnership interest and a $5.4 million loss on its
share of the Partnership’s operational losses for Fiscal Year 2006.                     Taxpayer
claimed the $29.9 million gain was nonbusiness income and reported an overall
taxable loss for Pennsylvania corporate net income tax (CNIT) purposes on the
2006 Pennsylvania corporate tax report.4                   The Department of Revenue
(Department) issued a notice of assessment dated October 13, 2009, disallowing
Taxpayer’s classification of the gain as nonbusiness income and imposing an
assessed CNIT in the amount of $2,243,291 for Fiscal Year 2006, plus interest.5


                                                B.
                Taxpayer filed an appeal with the Board of Appeals challenging the
Department’s classification of the gain as business income, asserting that the sale
of the partnership interest was nonbusiness income and should not be sourced to
Pennsylvania. Specifically, Taxpayer argued:

       3
           The 2006 Proforma federal return was prepared on a separate company basis.

       4
         Because it was unavailable, Taxpayer had the 2006 Proforma federal return prepared on
a separate company basis. Taxpayer had filed a consolidated federal income tax return as a
member of a consolidated group. Taxpayer informed the Commonwealth that its consolidated
federal income tax return was destroyed and not available. In lieu of Taxpayer’s consolidated
federal tax return copy, the affidavit of Marvin Antman, Taxpayer’s former accountant, was
provided to the Commonwealth with his explanation of the consolidated federal tax return filing
for Fiscal Year 2006.

       5
           The Department assessed interest in the amount of $286,439.00 as of October 23, 2009.




                                                5
                 The Taxpayer, who is a Delaware Taxpayer, had non-
                 business income from the sale of a partnership interest
                 that was not sourced to Penn [sic]. The capital gain from
                 the sale of the partnership interest is not business income
                 as the income was not income arising from transactions
                 & activity in the regular trade or business nor is it income
                 from tangible or intangible property since the
                 management and disposition of the [P]roperty were not
                 integral to the Taxpayer’s trade or business. The capital
                 gain should not be allocated to Pennsylvania. The
                 Taxpayer is not in the business of buying or selling their
                 [sic] partnership interest.


(Board of Appeals Petition at 2.) After a hearing, the Board of Appeals denied
Taxpayer’s request for classifying the sale of the partnership as nonbusiness
income, denied its request to source the sale outside of Pennsylvania and sustained
the Department’s assessment in its entirety.


                 Taxpayer appealed to the Board, requesting again nonbusiness income
treatment for the gain from the partnership interest sale and the ability to source the
sale outside of Pennsylvania and seeking to strike the Department’s assessment.
The Board denied Taxpayer’s request, finding that Taxpayer’s interests in the
Partnership subjected Taxpayer to CNIT because the Partnership does business in
Pennsylvania and the partnership sales gain constituted business income:

                 Because such income was derived from a transaction in
                 the regular course of [Taxpayer’s] business, investing in
                 real estate partnerships and receiving income from them.
                 Welded Tube Co.,[6] supra. The partnership sales gain
         6
             Welded Tube Company of America v. Commonwealth, 515 A.2d 988 (Pa. Cmwlth.
1986).




                                              6
            constituted business income for [Taxpayer] under the
            functional test because the acquisition and disposition of
            the investment partnerships constituted an integral part of
            [Taxpayer’s] regular trade or business, investment. See
            72 P.S. §7401(3)2.(a)(1)(A). [Taxpayer] is not entitled to
            allocate the partnership income under the [Code] because
            this income is apportionable business income. See 72
            P.S. §7401(3)2.(a)(4) (allocating rents, royalties, gains or
            interest only “to the extent they constitute nonbusiness
            income”); but see 72 P.S. §7401(3)2.(a)(9)(A)
            (subjecting all business income to apportionment).


(Board’s December 15, 2010 decision at 10) (footnote added).


            The Board further denied Taxpayer’s request for multiformity or
unrelated assets income treatment, explaining that Taxpayer’s tax return, petitions
and supporting materials do not show the unrelated nature of the income it seeks to
remove from taxation. With regard to Taxpayer’s request for exclusion of the
partnership sales gains from a sales fraction numerator, the Board reasoned that the
request is denied because the gains were apportionable business income and
“sales” included in the sales apportionment factor are all gross receipts not
allocated under the Code other than dividends, government obligation interest and
securities sales proceeds. The Board also found that the Partnership assets in
which Taxpayer held a direct interest were located in Pennsylvania, and the sale of
such assets makes Taxpayer’s sales gains Pennsylvania receipts correctly included
in a sales numerator. Finally, the Board found there to be no evidence that the sale
of the Partnership interest was “produced by a greater proportion of activity in
New York based on costs of performance given the circumstances of this case,”
thereby denying Taxpayer’s request to attribute the partnership sales proceeds to



                                         7
New York. (Board’s December 15, 2010 decision at 11.) This appeal by Taxpayer
followed.7


                                             II.
                                             A.
              At the outset, we must determine whether the gain realized by
Taxpayer from the sale of the Partnership interest is business or nonbusiness
income.


              “Pennsylvania’s corporate income tax is an excise tax on the privilege
of earning income and, therefore, under the Commerce Clause of the United States
Constitution, Pennsylvania may subject to taxation only that part of corporate
income reasonably related to the privilege exercised in this Commonwealth.”
Canteen Corporation v. Commonwealth of Pennsylvania, 818 A.2d 594, 597–98
(Pa. Cmwlth. 2003) (en banc), aff’d, 854 A.2d 440 (Pa. 2004) (per curiam). The
Code provides the general procedure for calculating Pennsylvania’s corporate
income tax and separates income into two classifications: “business income” or
“nonbusiness income.” “Business income” is defined as:

              [I]ncome arising from transactions and activity in the
              regular course of the taxpayer’s trade or business and
              includes income from tangible and intangible property if
              either the acquisition, the management or the disposition

       7
          In appeals from decisions of the Board of Finance and Revenue, our review is de novo
because we function as a trial court even though such cases are heard in our appellate
jurisdiction. Glatfelter Pulpwood Company v. Commonwealth of Pennsylvania, 19 A.3d 572,
576 n.3 (Pa. Cmwlth. 2011) (en banc), aff’d, 61 A.3d 993 (Pa. 2013).




                                              8
              of the property constitutes an integral part of the
              taxpayer’s regular trade or business operations. The term
              includes all income which is apportionable under the
              Constitution of the United States.


72 P.S. §7401(3)2.(a)(1)(A) (emphasis added). “Nonbusiness income” is defined
as:

              [A]ll income other than business income. The term does
              not include income which is apportionable under the
              Constitution of the United States.


72 P.S. §7401(3)2.(a)(1)(D).


              There are two alternative independent tests derived from the definition
of “business income” by which to evaluate whether income should be classified as
business income or nonbusiness income.8                      Ross–Araco Corporation v.
Commonwealth of Pennsylvania, Board of Finance and Revenue, 674 A.2d 691,
694 (Pa. 1996). Under the transactional test, which is based on the first clause of
the definition, a gain is “business income” if it is derived from a transaction in
which the taxpayer regularly engages.              Id. at 693.     This test “measures the
particular transaction against the frequency and regularity of similar transactions in



       8
          The Pennsylvania Supreme Court adopted in Laurel Pipe Line v. Commonwealth of
Pennsylvania, Board of Finance and Revenue, 642 A.2d 472, 474-75 (Pa. 1994), the
transactional and functional tests that this Court set forth in Welded Tube Company of America v.
Commonwealth of Pennsylvania, 515 A.2d 988, 993-94 (Pa. Cmwlth. 1986), to properly classify
income as “business income” or “nonbusiness income.”




                                               9
the past practices of the business.” Id. Also relevant in determining if a gain is
“business income” is the taxpayer’s subsequent use of the income. Id.


             The functional test is based on the second clause of the “business
income” definition and sets forth that “a gain from the sale of an asset is business
income if the corporation acquired, managed, or disposed of the asset as an integral
part of its regular business.” Glatfelter Pulpwood Company v. Commonwealth of
Pennsylvania, 61 A.3d 993, 1000 (Pa. 2013) (Glatfelter II). Moreover, a gain is
“business income” if it “arises from the sale of an asset that produced business
income while it was owned by the taxpayer.” Ross–Araco, 674 A.2d at 693.
However, for the purposes of this test, the “extraordinary nature or infrequency of
the transaction is irrelevant.” Id.


             Because the Commonwealth agrees that Taxpayer’s gain does not
satisfy the transactional test because Taxpayer’s sale of the Partnership interest was
a one-time event and not a transaction or activity in which Taxpayer regularly
engages, the only issue is whether it satisfies the functional test. Taxpayer asserts
that it does not meet the functional test because the sale of the Partnership interest
was a liquidation of a separate and distinct aspect of its business.


             Our Supreme Court in Glatfelter II addressed the issue of whether
income gained from liquidation of a business constituted an exception to the
income being deemed business income and determined that it did not.               The
taxpayer in that case argued, similarly to Taxpayer in this case, that the sale
constituted a partial liquidation of a unique aspect of the taxpayer’s business and,



                                          10
thus, was nonbusiness income. The taxpayer relied on Laurel Pipe and argued that
the Supreme Court had “carv[ed] out an exception from business income for gains
derived from the liquidation of a segment of a taxpayer’s business” and had
“arrived at its holding in Laurel Pipe without finding it necessary to parse the
statutory language of the definition of business income.” 61 A.3d at 1002. Noting
that Laurel Pipe was decided in 1994, before the 2001 amendment to the statutory
definition of “business income,” the Court explained:

            Whether the disposition of the timberland was also an
            integral part of Appellant’s regular business operations,
            pursuant to this Court’s precedent in Laurel Pipe, is not a
            matter that we need reach because only the acquisition or
            the management or the disposition of the property at
            issue need be an integral part of the taxpayer’s regular
            business operations under the plain text of the current
            statute. Accordingly, pursuant to the unambiguous
            statutory definition, Appellant’s gain from the sale of its
            Delaware timberland constitutes business income.

                                        ...

            Contrary to Appellant’s assertion … this Court did
            indeed parse, to the extent necessary, the statutory
            definition of business income in Laurel Pipe. As
            discussed above, the statutory definition applicable in
            Laurel Pipe was the pre–2001 version, requiring that “the
            acquisition, management, and disposition of the property
            constitute integral parts of the taxpayer’s regular trade or
            business.” … We concluded that the property at issue in
            Laurel Pipe was not disposed of as an integral part of the
            taxpayer’s regular trade or business, and having resolved
            the matter on this basis, there was no need for us to
            address the acquisition or management of the property.

            Thus, in Laurel Pipe, which was decided in 1994, our
            analysis and our holding were properly grounded in the
            statutory definition of business income that was in effect


                                        11
             at that time, prior to the 2001 amendments. We did not,
             as Appellant suggests, “carv[e] out an exception” to the
             definition. … Rather, we decided Laurel Pipe based
             upon the prior definition of business income in effect at
             the time, and we decide the case now before us based
             upon the revised definition currently in effect. In sum,
             Appellant’s net gain from the sale of the Delaware
             timberland constitutes business income, as that term is
             defined by the plain text of the current and only relevant
             definition.


Glatfelter II, 61 A.3d at 1004 (emphasis in original).


             Based on the stipulated facts, Taxpayer acquired its interests in the
Partnership for the purpose of gaining control over the Partnership.        As the
Partnership’s sole general partner, Taxpayer’s sole business activity was directing
and controlling the Partnership’s operations, including the Apartment Complex
operations through its officers and directors. Moreover, RB Assets, Taxpayer’s
indirect parent, strategically acquired the lender’s rights to the Secured Loan in
order for Taxpayer to operate and control on its behalf the Partnership and
Apartment Complex. Taxpayer’s subsequent sale of a portion of its Partnership
interest was, therefore, in line with “the management or the disposition of the
property constitut[ing] an integral part of the taxpayer’s regular trade or business
operations management,” and, thus, the income gained from the sale is business
income. Glatfelter Pulpwood Company v. Commonwealth of Pennsylvania, 19
A.3d 572, 578 (Pa. Cmwlth. 2011) (Glatfelter I) (citation omitted).




                                         12
                                         B.
             Alternatively, Taxpayer argues that if the gain is indeed deemed
business income, the gain must be excluded from Taxpayer’s apportionable tax
base under the doctrines of multiformity or unrelated assets. “Apportionable”
income is income that “is divided among states with some nexus to the business
based on a formula.”       Glatfelter I, 19 A.3d at 576.       More specifically, in
calculating the business income of a multistate corporation, Pennsylvania
“employs a formula based on the ratio of three factors, to wit, the corporation’s
payroll, property, and sales within Pennsylvania, to the corporation’s total payroll,
property, and sales, respectively.” Glatfelter II, 61 A.3d at 999 (citations omitted).
The constitutional theory of multiformity provides that a state may not tax value
earned outside its borders unless there is “some definite link, some minimum
connection, between a state and the person, property or transaction it seeks to tax.”
Miller Bros. Co. v. Maryland, 347 U.S. 340, 344-45 (1954).


             Taxpayer contends that because it acquired its partnership interests
not for the purpose of engaging in the Partnership’s real estate rental operations but
instead to give its lender control of the Partnership on account of the Partnership’s
default in the loan, the gain from the sale of the partnership interest cannot be
apportioned to Pennsylvania using the pass-through apportionment factors related
to the real estate rental operations conducted by the Partnership.


             In Commonwealth of Pennsylvania v. ACF Industries, Incorporated,
271 A.2d 273, 276 (Pa. 1970), the Pennsylvania Supreme Court established that a
taxpayer may exclude all of its gain when reporting its corporate net income to



                                         13
Pennsylvania when “the taxpayer either (1) is engaged in a separate business
outside of Pennsylvania (the so-called ‘multiform’ concept) or (2) owns an asset or
assets unrelated to the exercise of its franchise or the conduct of its activities in
Pennsylvania (the so-called ‘unrelated asset’ concept).”       Recognizing that the
multiform or unrelated asset cases are “unique” and highly dependent upon factual
considerations, the Court presented three principles to follow in deciding whether
apportionment is allowed:

             First, if a multistate business enterprise is conducted in a
             way that one, some or all of the business operations
             outside Pennsylvania are independent of and do not
             contribute to the business operations within this State, the
             factors attributable to the outside activity may be
             excluded.

             Second, in applying the foregoing principle to a
             particular case, we must focus upon the relationship
             between the Pennsylvania activity and the outside one,
             not the common relationships between these and the
             central corporate structure. Only if the impact of the
             latter on the operating units or activities is so pervasive
             as to negate any claim that they function independently
             from each other do we deny exclusion in this context.

             Third, without attempting to preclude exclusion in any
             given case, we reiterate our statement above that the
             manufacturing,     wholesaling    and     retailing (or
             manufacturing and selling) activities of a single
             enterprise are not fit subjects for division and partial
             exclusion. On the other hand, a truly divisionalized
             business, conducting disparate activities with each
             division internally integrated with respect to
             manufacturing and selling, may well be in a position to
             make a valid claim for exclusion.




                                         14
Id. at 279-80.9


               Taxpayer acknowledged in the Stipulation that it acquired its interests
in the Partnership for the purpose of gaining control over the Partnership and
thereafter directed and controlled both the Partnership and the Apartment
Complex, located in Pennsylvania, to operate them as an integrated whole.
Taxpayer then made a strategic business decision to sell a portion of its interest in
the Partnership, but retained a 42.36% limited partnership interest, continued to be
the sole general partner and maintained its operations over the Partnership as
before. For these reasons, we conclude that Taxpayer’s interest in the Partnership
was integrally related to its business activities in Pennsylvania and, thus, the
income from the sale of the Partnership interest is subject to tax in Pennsylvania as
business income.




       9
          The Commonwealth argues that the multiformity or unrelated assets doctrines are
antiquated and no longer apply as they were developed out of 1930-40s era Pennsylvania case
law attempting to apply the Due Process and Commerce Clauses of the United States
Constitution to the Pennsylvania foreign franchise tax. The Commonwealth maintains that ACF
Industries’ holding as it relates to the multiformity or unrelated assets doctrines is inapplicable in
this case because ACF Industries was decided before the Code was enacted and, instead, it
interpreted a 1965 amendment to a 1935 statute, which has long been repealed. The
Commonwealth argues that although some of the ACF Industries’ era analysis may be similar, it
does not control the interpretation of the current Pennsylvania definition of business and
nonbusiness income adopted by our legislature. Although the Commonwealth is correct in that
ACF Industries analyzed a statute that is not relevant to this case and that it was decided before
the Code was even enacted, this Court, in Glatfelter I and the Supreme Court in Glatfelter II,
used ACF Industries in determining whether the multiformity or unrelated assets doctrines apply,
even after the definition of “business income” was amended in 2001.




                                                 15
                                                C.
               Taxpayer next contends that if the gain is apportionable business
income, the gross proceeds from the sale of the partnership interest should be
sourced to New York, the state in which Taxpayer is headquartered, for purposes
of calculating the sales factor10 of Taxpayer’s corporate net income tax
apportionment fraction. Taxpayer argues that the sale of its partnership interest is
a sale of intangible personal property for federal income tax purposes and not a
sale of its proportionate share of the Partnership’s underlying assets or a sale by the
Partnership of its assets. It argues that because the calculation of its corporate net
income tax base starts with its federal taxable income, and the gain realized on the
sale of the Partnership interest is treated as gain from the sale of intangible
property for federal income tax purposes, the gross proceeds must likewise be
treated as realized from the sale of intangible property for corporate net income tax
purposes and sourced to New York pursuant to Section 401(3)2.(a)(17) of the Code
because all of the activities associated with the acquisition, holding and disposition
of the Partnership interest occurred at the headquarters in New York. We disagree.


               Section 401(3)2.(a)(17) of the Code provides that:

               Sales, other than sales under paragraphs (16) and (16.1)
               [(relating to sales of tangible personal property and real
               property)], are in this State if:


       10
          Section 401(3)2.(a)(15) of the Code defines “sales factor” as “a fraction, the numerator
of which is the total sales of the taxpayer in this State during the tax period, and the denominator
of which is the total sales of the taxpayer everywhere during the tax period.” 72 P.S.
§7401(3)2.(a)(15).




                                                16
                   (A) The income-producing activity is performed in
            this State; or

                   (B) The income-producing activity is performed
            both in and outside this State and a greater proportion of
            the income-producing activity is performed in this State
            than in any other state, based on costs of performance.


72 P.S. §7401(3)2.(a)(17).


            Taxpayer’s income-producing activity, the operation and management
of the Apartment Complex and the Partnership, are performed in Pennsylvania.
The stipulated facts indicate that the Apartment Complex is located in Philadelphia
and that Taxpayer’s duty is to operate the Apartment Complex. In selling a portion
of its Partnership interest, Taxpayer gained income from transferring a portion of
its interest in the Partnership and Apartment Complex, located in Pennsylvania.
Moreover, any costs that arise in producing the income, that is, operating the
Partnership and the Apartment Complex, are generated in Pennsylvania. Nothing
in the stipulated facts suggests otherwise or establishes that Taxpayer is involved
in income-producing activities and their related costs outside of Pennsylvania.


                                        D.
            Even if the money derived from a sale of the partnership interest is
business income and all of that income is apportionable to Pennsylvania, Taxpayer
contends that the tax benefit rule described in Wirth v. Commonwealth of
Pennsylvania, 95 A.3d 822, 845-46 (Pa. 2014), involving the Pennsylvania
personal income tax (PIT), should be applied to this case to allow it to exclude
from business income the gain from the sale.


                                        17
                                               1.
               The “tax benefit rule” is not constitutionally mandated, but instead is a
product of federal common law that has its genesis in the United States Supreme
Court cases of Dobson v. Commissioner, 320 U.S. 489 (1943) and Hillsboro
National Bank v. Commissioner, 460 U.S. 370 (1983). It is now codified in
Section 111 of the Internal Revenue Code (IRC).11 As we stated in Marshall v.
Commonwealth, 41 A.3d 67, 93 (Pa. Cmwlth. 2012):

       11
          The Internal Revenue Code codifies the application of the tax benefit rule, providing in
pertinent part:

               (a) Deductions.--Gross income does not include income
               attributable to the recovery during the taxable year of any amount
               deducted in any prior taxable year to the extent such amount did
               not reduce the amount of tax imposed by this chapter.

               (b) Credits.--

                       (1) In general.--If--

                             (A) a credit was allowable with respect to any
               amount for any prior taxable year, and

                             (B) during the taxable year there is a downward
               price adjustment or similar adjustment,

               the tax imposed by this chapter for the taxable year shall be
               increased by the amount of the credit attributable to the
               adjustment.

                       (2) Exception where credit did not reduce tax.--Paragraph
               (1) shall not apply to the extent that the credit allowable for the
               recovered amount did not reduce the amount of tax imposed by
               this chapter.

26 U.S.C. §111.




                                               18
             [T]he tax benefit rule is not a generic doctrine prescribed
             by the courts to remedy every apparent or perceived
             inequity or unfairness in an income tax system, state or
             federal. To the contrary, it was created to address a
             specific and particular inequity in the tax system caused
             by the annual accounting system for taxation. As the
             United States Supreme Court [in Hillsboro, 460 U.S. at
             389] recognized:

                The limited nature of the rule and its effect on the
                annual accounting principle bears repetition: only
                if the occurrence of the event in the earlier year
                would have resulted in the disallowance of the
                deduction can the Commissioner require a
                compensating recognition of income when the
                event occurs in the later year.


(Emphasis in original.)


             In explaining the exclusionary aspect of the tax benefit rule, our
Supreme Court in Wirth stated that the tax benefit rule:

             [A]pplies when a deduction of some sort for a loss is
             taken by a taxpayer in one year, only to have the amount
             previously deducted recovered in a following tax year.
             Normally, the taxpayer would be responsible for
             including the recovered income on his personal income
             tax return for the year in which recovery occurred. The
             tax benefit rule states, however, that the recovery of the
             previously deducted loss is not includible to the extent
             that the earlier deduction did not reduce the amount of
             the tax owed in the year the initial deduction was taken.
             Put differently, the “rule permits exclusion of the
             recovered item from income [in a subsequent tax year] so
             long as its initial use as a deduction did not provide a tax
             saving.” Commentators upon the rule have stated that it
             is “both a rule of inclusion and exclusion: recovery of an
             item previously deducted must be included in income;

                                         19
            that portion of the recovery not resulting in a prior tax
            benefit is excluded.”


Wirth, 95 A.3d at 845-46 (citations omitted).


                                         2.
            Wirth was the first case that addressed the tax benefit rule application
to Pennsylvania taxes and it found that the tax benefit rule was not applicable to a
tax imposed under the PIT. That case did not discuss whether we should adopt this
federal common law rule into Pennsylvania tax law, but stated “the Department has
seemingly incorporated the rule into Pennsylvania tax law through Table 16-2.”
Wirth, 95 A.3d at 848 (emphasis added). Rather than address that claim, both this
Court and our Supreme Court just conducted an analysis to see if it had any tax
consequence. Similarly, this is the first time we have been asked to consider
whether the tax benefit rule should be adopted for the purpose of how the CNIT is
imposed.


            The CNIT begins with “federal taxable income” as determined by the
provisions of the IRC. 72 P.S. §7401(3)2.(a)(1)(A). The Department of Revenue’s
regulations (Regulations) further define federal taxable income, in pertinent part,
as “income before net operating loss deduction and special deductions … or
adjusted under 401(3)1 of the [Code] (72 P. S. §7401(3)1.).” 61 Pa. Code §153.11.
We have held that, unless the statutory scheme indicates otherwise, the reference to
“federal taxable income” as “incorporat[ing] … those provisions of the IRC which
go toward the computation of taxable income for federal purposes.”




                                        20
Commonwealth v. Rohm and Haas Company, 368 A.2d 909, 912 (Pa. Cmwlth.
1977).


              In their Stipulation of Facts, the parties state that Taxpayer reported a
$29.9 million capital gain on its 2006 Proforma federal return. The gain was
calculated as the amount realized from the sale of the Partnership interest in the
amount of $29.9 million minus Taxpayer’s basis in the Partnership interest, zero.12
See 26 U.S.C. §741; 26 C.F.R. §1.741-1(a).                 The amount realized includes
Taxpayer’s share of the Partnership’s nonrecourse debt attributable to the sale of
the Partnership interest and assumed by the Buyer. Taxpayer did not pay any
federal income tax on the taxable gain from the sale for the 45% limited
Partnership interest because it had federal net operating loss carryovers to offset
the gain. Federal net loss carryovers can be used for 20 years after they are
incurred and have no limit on the amount that can be deducted.                           While
Pennsylvania also has a 20 year net loss carryover, only $2 million of that
carryover can be deducted from Pennsylvania income in the 2006 tax year.


                                               3.
              Taxpayer claims that we should adopt the tax benefit rule to allow it
to use those carryovers in excess of the $2 million cap because it would restore its
basis in the Partnership interest in “an amount equal to the Partnership’s



       12
          Taxpayer explains that the gain on the sale of its 45% limited partnership interest was
based on dividing its 45% limited partnership interest by its 87.36% total limited partnership
interest.




                                               21
operational losses passed through to [Taxpayer] that could not be utilized by
[Taxpayer] for [corporate net income] tax purposes.” (Petitioner’s Brief at 14-15.)


             In analyzing whether Taxpayer should be allowed to have the benefit
of the exclusionary aspect of the tax benefit rule, let us first start with Wirth and
assume that the tax benefit rule has been adopted in Pennsylvania. In Marshall, 41
A.3d at 94, a companion case to Wirth, quoting from John Hancock Financial
Services v. United States, 378 F.3d 1302, 1305 (Fed. Cir. 2004), we held that at a
minimum, taxpayers seeking to avail themselves of the exclusionary aspect of the
tax benefit rule must establish three requirements: “First, there must be a loss that
was deducted but did not result in a tax benefit. Second, there must be a later
recovery on the loss. Third, there must be a nexus between the loss and the
recovery.” (Emphasis in Marshall). Moreover, in Marshall, we stated that the tax
benefit rule cannot be used in a way that abrogates provisions of the IRC and/or the
Regulations, or where application of the rule would result in a deduction expressly
prohibited by the IRC.


             Under the first prong of that test, Taxpayer has the burden to establish
that it has attempted to take the deduction from which it received a tax benefit in a
prior year. As our Supreme Court stated in Wirth:

             Dobson and its progeny, as well as Section 111 [of the
             IRC], all require that the attempted exclusion of realized
             gain be related to a deduction without tax consequence
             from a prior year. [Taxpayers] have not pointed to any
             jurisprudence, regulation, or Department policy that
             states otherwise. Through all of their protestations
             regarding the mandatory application of the exclusionary
             arm of the tax benefit rule, [taxpayers] never address this

                                         22
               salient point, nor, more importantly, when they attempted
               to take the required prior deduction.


95 A.3d at 848. Nothing in the Stipulation states that Taxpayer attempted to take a
tax deduction in a prior year without tax consequences; nor have any tax returns
been filed for the prior years. For this reason alone, because Taxpayer has failed to
meet its burden, the tax benefit rule cannot be used in this case.


               As to the second and third prong of the test – requiring that there must
be a later recovery on the loss as well as a nexus between the loss and the recovery
– these prongs are intertwined. We agree with the Commonwealth that Taxpayer
does not meet these two prongs because the deductions it seeks to recoup are
operating expenses that cannot be deducted under the tax benefit rule because its
losses are in no way related to the capital gain from the sale of the Partnership
interest.13



       13
         See In re Appeal of H.V. Management Corporation, Decision of July 29, 1981, Cal. Bd.
of Equalization (1981), available at: http://www.boe.ca.gov/legal/pdf/81-sbe-081.pdf (last visited
May 25, 2016).

        H.V. Management Corporation is substantially similar to this case. The taxpayer in that
case was a corporation that was a general partner in a partnership that developed real estate in
California. Like here, the taxpayer did not have other activities or investments other than its
interest in the partnership. The taxpayer reported losses from its share of the partnership losses
and reported the partnership losses on its federal and state income tax returns. After selling its
partnership interest at a gain, the taxpayer attempted to reduce the gain by the amount of its
aggregate prior years, asserting that the tax benefit rule excluded the gain. Holding that the tax
benefit rule was not applicable, the California Equalization Board reasoned that the taxpayer’s
operational losses were separate transactions from the taxpayer’s gain on the sale of the
partnership interest.




                                               23
                                          4.
             The Commonwealth also contends that the application of the tax
benefit rule does not apply to this case because to do so would be in conflict with
the United States Department of Treasury Regulations (Treasury Regulations)
Section 1.111-1(a) that disallows depreciation as an expense under the tax benefit
rule. The regulation provides, in pertinent part:

             The rule of exclusion so prescribed by statute applies
             equally with respect to all other losses, expenditures and
             accruals made the basis of deductions from gross income
             for prior taxable years … but not including deductions
             with respect to depreciation, depletion, amortization, or
             amortizable bond premiums.


26 CFR §1.111-1(a) (emphasis added).


             In response, Taxpayer first argues that the Commonwealth’s
assumption that the losses it seeks to exclude were for depreciation is erroneous
because the losses were created by the deduction of a number of expenses incurred
in the operation of a rental property, including advertising, insurance, interest,
wages and salaries and real estate taxes. Depreciation accounted for only a portion
of the deductions that created the losses at issue. Unfortunately, Taxpayer does not
give us a breakdown of those expenses and neither the Stipulation nor the tax
returns set forth how the losses were incurred. We do note, though, that the gain
on the federal tax return was characterized as a capital gain.


             More substantively, while acknowledging that it does permit
depreciation from being excluded from income under the tax benefit rule,

                                          24
Taxpayer contends that Section 1.111-1(a) of the Treasury Regulations goes
beyond the language of Section 111 of the IRC as a result of a 1984 amendment to
IRC Section 111(a) that removed any reference to debts, prior taxes and
delinquency as the only type of items that were subject to the tax benefit rule. IRC
Section 111(a) was broadened to address any recovery:

            Gross income does not include amounts attributable to
            the recovery during the taxable year of any amount
            deducted in any prior taxable year to the extent such
            amount did not reduce the amount of tax imposed by this
            chapter.


26 U.S.C. §111(a). As a result, Taxpayer claims that given the amendment, there
are now no limitations on the type of deductions that can be excluded from income.


            However, as far as we can discern, this regulation has not been
challenged and, after the amendment in American Mutual Life Company v. United
States, 46 Fed. Cl. 445 (2000), it was used by analogy not to allow a life insurance
company to exclude from income certain decreases in life insurance reserves
otherwise required to be included as income under the IRC.


            Given that the IRC grants authority to the United States Department
of Treasury to “prescribe all needful rules and regulations for the enforcement of
this title,” 26 U.S.C. §7805(a), and under Chevron U.S.A., Inc. v. Natural
Resources Defense Council, Inc., 467 U.S. 837 (1984), courts are required to
afford an agency discretion to interpret a provision of the agency’s organic or
enabling statute unless it is inconsistent with the provisions of that statute, we


                                        25
decline to find the Regulation invalid. If we had found that the tax benefit rule was
applicable, we would have ordered a hearing to take evidence on what portion of
the deduction was attributable to depreciation; but that is not necessary for the
reason set forth, as well as the fact that it is in conflict with the Code provisions
regarding the CNIT.


               In this case, only tax year 2006 is at issue and Section
401(3)4.(c)(1)(A)(I) of the Code, 72 P.S. §7401(3)4.(c)(1)(A) (I), provides that for
taxable years beginning before January 1, 2007, the net loss carryover deduction is
limited to $2 million. Taxpayer’s contention that the tax benefit rule should apply
because it would otherwise forego the deductions above the $2 million limitation
in effect would remove all caps on the net loss carryover, a direct contravention of
the above-cited provisions of the Code. In the context of the CNIT, we decline to
adopt the tax benefit rule.


                                               E.
               Relying on Nextel Communications of Mid-Atlantic, Inc. v.
Commonwealth of Pennsylvania, 129 A.3d 1 (Pa. Cmwlth. 2015), Taxpayer argues
that if the gain is apportionable business income, it is entitled to claim a net loss
carryover deduction in an amount equal to 100% of its income apportioned to
Pennsylvania.14 It contends that limiting its net loss carryover deduction to the $2

       14
          The net loss carryover provision of the Code, 72 P.S. §7401(3)4.(c)(1)(A)(II), enables a
taxpayer to reduce its positive taxable income in a particular year by deducting prior year net
losses (i.e., where the taxpayer had negative taxable income), thus reducing the amount of
corporate net income tax due and payable in that tax year. Net losses from prior tax years may
be carried over to subsequent tax years and applied to reduce taxable income according to a
schedule set forth in Section 401(3)4.(c)(2) of the Code, 72 P.S. §7401(3)4.(c)(2). The Code
(Footnote continued on next page…)

                                               26
million as allowed by the Department violates the Uniformity Clause of the
Pennsylvania Constitution, Pa. Const. art. VIII, §1, because it favors smaller
taxpayers in positive net loss carryover positions over similarly-situated larger
taxpayers, and imposes disparate tax burdens on taxpayers based solely on the
amount of income earned.15


                The Commonwealth acknowledges that this Court held in Nextel that
the Pennsylvania net loss carryover deduction violates the Uniformity Clause.
However it asserts that the decision was limited in application to the
Commonwealth, the taxpayer in Nextel and the 2007 tax year.16                                   The

(continued…)

limits the number of years a taxpayer may carry over its net losses as well as the amount of the
net loss carryover deduction a taxpayer may take in any given tax year. For Fiscal Year 2006,
for example, the amount of the net loss carryover deduction was $2 million. 72 P.S.
§7401(3)4.(c)(1)(A)(I).

       15
           In challenging the constitutionality of tax legislation, a taxpayer bears a heavy burden.
Leonard v. Thornburgh, 489 A.2d 1349, 1351 (Pa. 1985). The taxpayer must establish: (1) that
the provision results in some form of classification, and (2) that the classification is
“unreasonable and not rationally related to any legitimate state purpose.” Clifton v. Allegheny
County, 969 A.2d 1197, 1211 (Pa. 2009). However, “tax legislation is presumed to be
constitutionally valid and will not be declared unconstitutional unless it ‘clearly, palpably and
plainly violates the constitution.’” Nextel, 129 A.3d at 8 (quoting Free Speech, LLC v. City of
Philadelphia, 884 A.2d 966, 971 (Pa. Cmwlth. 2005)). That is, “[a]ny doubts regarding the
constitutionality of tax legislation should be resolved in favor of upholding its constitutionality.”
Id.

       16
            In making this argument, the Commonwealth noted that we clarified in Nextel:

                [O]ur analysis and remedy is appropriately confined to the
                Commonwealth, Nextel, and the 2007 Tax Year. To the extent our
                decision in this as-applied challenge calls into question the validity
                of the [net loss carryover] deduction provision in any other or even
(Footnote continued on next page…)

                                                 27
Commonwealth further contends that unlike the taxpayer in Nextel, the Taxpayer
here did not establish that the net operating loss deduction was unconstitutional as
applied to it.


                 Indeed, we held in Nextel that based on Section 401(3)4.(c)(1)(A)(II)
of the Code, the net loss carryover deduction provision that allows a net loss
deduction that is the greater of the flat percentage of net losses or of a flat capped
amount violates the Uniformity Clause. We also, as the Commonwealth states,
limited the aforementioned holding to the parties in Nextel and the 2007 tax year.
However, that does not preclude us from performing the same analysis as we did in
Nextel in determining whether the net loss carryover deduction, insofar as it applies
to Taxpayer, also violates the Uniformity Clause.


                 The Uniformity Clause states: “All 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. Additionally:

                 [a]lthough the Uniformity Clause does not require
                 absolute equality and perfect uniformity in taxation, the
                 legislature cannot treat similarly-situated taxpayers
                 differently. Where the validity of a tax classification is
                 challenged, “the test is whether the classification is based
                 upon some legitimate distinction between the classes that


(continued…)

                 every other context, the General Assembly should be guided
                 accordingly.

(Respondent’s Brief at 58) (quoting Nextel, 129 A.3d at 13) (emphasis in brief).



                                               28
             provides a non-arbitrary and ‘reasonable and just’ basis
             for the difference in treatment.” In other words, “[w]hen
             there exists no legitimate distinction between the classes,
             and, thus, the tax scheme imposes substantially unequal
             tax burdens upon persons otherwise similarly situated,
             the tax is unconstitutional.”


Nextel, 129 A.3d at 8 (citations omitted).


             For Fiscal Year 2006, Section 401(3)4.(c)(1)(A)(I) of the Code
limited the amount of the net loss carryover deduction to the lesser of $2 million or
the actual amount of the net loss carryovers available for carryover to the tax year.
Based on the parties’ stipulated facts, in its 2006 Pennsylvania report, Taxpayer
reported $43,706,696 of accumulated net loss carryovers.           The losses were
generated by the unused operational losses passed through to it from the
Partnership in the tax years prior to Fiscal Year 2006.        Of the $43,706,696
accumulated net loss carryovers, pursuant to Section 401(3)4.(c)(2), $38,969,295
were available for carryover to Fiscal Year 2006.           However, per Section
401(3)4.(c)(1)(A)(I) of the Code, Taxpayer was limited to a $2 million deduction.


             The stipulated facts show that the net loss carryover provision creates
classes of taxpayers based on their taxable income. For Fiscal Year 2006, the net
loss carryover provision can and likely did allow some taxpayers to reduce their
taxable income to $0 and not have to pay any CNIT. However, that provision can
also prevent other taxpayers, as in this case, from reducing their taxable income to
$0 and cause these taxpayers to pay CNIT. For Fiscal Year 2006, where both
classes of taxpayers entered the 2006 tax year in a positive net operating loss
carryover position, the only distinguishing factor between the two classes of

                                         29
taxpayers is the amount of taxable income that year. Those with $2 million or less
in taxable income for Fiscal Year 2006 could offset up to 100% of the taxable
income as the statute allows a $2 million deduction. However, taxpayers with
more than $2 million in income for Fiscal Year 2006 could only offset $2 million
and pay CNIT on the remaining income.


            In holding the cap on the net loss carryover unconstitutional, we
reasoned:

            To the extent the General Assembly exercises its power
            to tax property, it cannot set a valuation threshold that, in
            effect, exempts some property owners from the tax
            entirely…. Here, the General Assembly has elected to
            tax property—i.e., corporate net income. It has also
            allowed taxpayers to deduct from their taxable income
            carryover net losses from prior years. By capping that
            deduction at the greater of $3 million or 12.5% of taxable
            income, however, the General Assembly has favored
            taxpayers whose property (i.e., taxable income) is valued
            at $3 million or less. To the extent these taxpayers are in
            a positive net loss carryover position, they pay no
            corporate net income tax—i.e., they have no tax burden.
            A similarly-situated taxpayer with more than $3 million
            in taxable income, however, cannot avoid paying tax
            under the [net loss carryover] deduction provision. The
            distinction is based solely on asset value, which is, under
            Cope’s Estate, “unjust, arbitrary, and illegal.” Moreover,
            the fact that the [net loss carryover] deduction provision
            enabled 98.8% of taxpayers in a positive net loss
            carryover position to avoid paying any tax in 2007,
            leaving 1.2% of similarly-situated taxpayers to pay some
            tax, “illustrates the injustice and inequality that must
            result from such special legislation.”




                                         30
Nextel, 129 A.3d at 10-11 (citations and footnote omitted). A similar reasoning
applies to this case, with the exception being that the cap is $2 million instead of
three.


             Based on the foregoing, Taxpayer requests that we remedy Section
401(3)4.(c)(1)(A)(I)’s uniformity violation in the same way as we did in Nextel by
eliminating the cap on the net loss carryover. Accordingly, because the net loss
carryover provision contained in Section 401(3)4.(c)(1)(A)(I) of the Code is
unconstitutional, we reverse the Board’s decision on that basis and calculate the tax
without a cap on the net loss carryover.



                                       ______________________________
                                       DAN PELLEGRINI, Senior Judge




                                           31
          IN THE COMMONWEALTH COURT OF PENNSYLVANIA


RB Alden Corp.,                      :
                    Petitioner       :
                                     :
             v.                      : No. 73 F.R. 2011
                                     :
Commonwealth of Pennsylvania,        :
                Respondent           :




                                   ORDER


             AND NOW, this 15th day of June, 2016, it is hereby Ordered that the
order of the Board of Finance and Revenue dated December 17, 2010, at No.
1000719 is reversed, and the Department of Revenue is directed to calculate RB
Alden Corp.’s corporate net income tax without capping the amount that it can take
on its net loss carryover.



                                     ______________________________
                                     DAN PELLEGRINI, Senior Judge
