The Pennsylvania Supreme Court has upheld the First Union rule, which provides that when an entity is formed through the combination of a Pennsylvania bank and an out-of-state bank, the out-of-state bank’s pre-merger value is not to be factored into the six-year average share value calculation under the shares tax provision of the Pennsylvania Tax Reform Code.
The court ruled 4-2 to reverse a Commonwealth Court ruling in Lebanon Valley Farmers Bank v. Commonwealth that held that when a Pennsylvania bank and an out-of-state bank merge, only the post-merger values of each can be factored into the taxable share value calculation layed out in the Tax Code.
The lower court’s ruling effectively overturned the portion of its own 2005 decision in First Union National Bank v. Commonwealth that held an out-of-state bank’s pre-combination value may not be included in the average taxable share calculation.
In Lebanon Valley, the court found that a “‘limited severance’” of the averaging provision should be applied when a Pennsylvania bank merges with an out-of-state bank because assigning a zero taxable share to the out-of-state bank pre-merger dilutes the value of the new entity and results in a loss of tax revenue.
Justice J. Michael Eakin, writing for the majority in Lebanon Valley, said an out-of-state bank’s assets were not within the reach of Pennsylvania tax prior to its combination with a Pennsylvania firm, thus distinguishing such a merger from one that combines two Pennsylvania banking “institutions”—banks that have been in existence for six or more years—under the Tax Code.
“Because the averaging provision is the method of calculating tax, the additional assets will not be immediately reflected dollar-for-dollar in the average taxable assets of the post-merger institution,” Eakin said. “What is significant, however, is that the adding of assets to the reach of Pennsylvania’s tax law is a tangibly different scenario than merging two previously taxed institutions. This in turn justifies the short-term disparity of result that lies at the heart of the present appeal, for the situations are sufficiently distinguishable to warrant distinguishable results.”
Eakin said Pennsylvania benefits from these mergers because “the addition of taxable assets enriches the public coffers.”
Eakin was joined by Chief Justice Ronald D. Castille and Justices Debra Todd and Seamus P. McCaffery.
Justice Thomas G. Saylor, joined by Justice Max Baer, penned a dissenting opinion, arguing that excluding out-of-state banks from the six-year average share calculation violates the Uniformity Clause of the Pennsylvania Constitution.
Saylor said the shares tax provision was designed to tax the value of a newly formed entity’s shares in the current tax year and uses the six-year average as a way to account for potential fluctuations.
“Although perhaps not a perfect analogy, it is as if the court were to declare that tax uniformity was satisfied by either: (1) a municipal property tax on mobile homes that was substantially lower for mobile homes that had been brought into the municipality within the past six years; or (2) a state income tax levied on workers who moved to Pennsylvania within the last six years at only a fraction of the rate for longstanding in-state workers,” Saylor said. “The relocated mobile home or income stream in such a case would be ‘new to the reach’ of the tax, but that would be of little relevance to the uniformity analysis.”
Saylor also took issue with Eakin’s rationale that a Pennsylvania bank’s merger with an out-of-state bank enriches the public coffers with newly taxable assets.
According to Saylor, the majority “overlooks that the institution may apportion the taxable value of its shares according to the percentage of its total payroll, receipts and deposits that are located in Pennsylvania.”
“If the extraterritorial bank delays in bringing any of these items into the commonwealth, not only will Pennsylvania not benefit, but it will lose significant revenue due to the distorting effects of the First Union rule on the commonwealth’s ability to tax in-state assets,” Saylor said.
In Lebanon Valley, according to Eakin, Pennsylvania banking institutions Farmers Bank and Lebanon Valley National Bank merged, forming Lebanon Valley Farmers Bank.
Under the Tax Code, the share tax calculation for the 2002 tax year took into account both banks’ six-year pre-merger share values, Eakin said.
But in 2005, LVFB petitioned the state Board of Appeals for a refund of the portion of its 2002 tax payment that was based on National Bank’s pre-merger share value, arguing that the First Union rule violates the uniformity clause by treating intrastate and interstate bank mergers differently, Eakin said.
When the Board of Appeals denied the petition, LVFB appealed to the state Board of Finance and Revenue, which, relying on First Union, also denied the petition, according to Eakin.
A panel of the Commonwealth Court initially affirmed, Eakin said, but the court en banc heard reargument and found that the First Union rule impermissibly allows Pennsylvania banks that merge with out-of-state banks to dilute their taxable values in a way that Pennsylvania banks that merge with other Pennsylvania banks cannot.
Therefore, the Commonwealth Court found, a combination involving a Pennsylvania firm and an out-of-state firm must be taxed as a new institution based only on post-merger values, according to Eakin.
But Eakin said the “averaging provision is not an adjunct section applicable or inapplicable depending on the corporate history of the institution.”
“The averaging provision clearly applies to all institutions and does not speak at all to combinations,” Eakin said. “The combination provision in turn is silent on the methodology applicable to a combination of an institution and a non-institution; in that situation, it simply does not apply.”
Eakin added that the joining together of “two institutions, both previously taxed on their historic average values, is a different scenario than a combination that introduces previously untaxable assets to the calculation.”
“We see no unconstitutional disparity of treatment in this legislative scheme,” Eakin said.
Counsel for LVFB, David M. Kuchinos of Blank Rome in Philadelphia, could not be reached for comment at press time.
A spokesman for the state Office of Attorney General also could not be reached.
(Copies of the 20-page opinion in Lebanon Valley Farmers Bank v. Commonwealth, PICS No. 13-3410, are available from Pennsylvania Law Weekly. Please call the Pennsylvania Instant Case Service at 800-276-PICS to order or for information.) •