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In a decision that the lawyers for Montgomery County, Penn. and other counties are touting as a victory, the Pennsylvania high court has ruled billionaire Walter Annenberg and his wife are not entitled to a full refund of the personal-property taxes they paid on stock in out-of-state companies. The court ruled that the counties defending the tax did not prove that it is constitutional. But the constitutionally offensive “stock clause” — which effectively provided an exemption for stock in in-state companies — could be severed from the property tax statute, leaving a constitutional tax on stock held in all companies. While the five-justice majority, led by Justice Stephen Zappala, declined to order a full refund of the taxes collected from the Annenbergs, the court did say that the county would have to develop some appropriate retrospective remedy. But that’s a big win for Montgomery County, which reportedly had about $68 million on the line had the court ruled in favor of the full refund. “We’re pleased with the Supreme Court’s decision,” said Joseph McAlee of Sprague & Sprague, attorney for eight intervening counties and the state association of county commissioners. The situation is now in the hands of Montgomery and the other counties to fashion their own appropriate remedies. “Each county will have to make its own decision,” McAlee said. Steven Hann of Hamburg Rubin Mullin Maxwell & Lupin, attorney for Montgomery County, said he didn’t know what his client would do. The county will have to look at the various remedies available and evaluate them, he said. Steven Lupin was the lead counsel for the county. The Annenbergs’ lawyer, Peter Picotte Jr. of Dilworth Paxson, did not return a phone call for comment. BACKGROUND The tax on corporate shares of out-of-state companies was imposed under a state law. Walter Annenberg and his wife challenged the state tax as unconstitutional, claiming it violated the Commerce Clause of the U.S. Constitution. “The portion of the stock clause tax which the Annenbergs attacked as being unconstitutional … excludes from personal property tax stock held in entities to which the capital stock and franchise tax apply,” the court explained in a footnote. “The net effect of the stock clause is that the only stock on which an owner is liable to pay tax pursuant to the stock clause is on stock in foreign corporations which do not do business in Pennsylvania.” In the Supreme Court’s first decision in this case, it ruled that the stock clause of the personal-property tax facially discriminated against interstate commerce. “However we did not declare that the stock clause was unconstitutional at that point,” the court said. “Rather, we noted that a tax provision which is facially discriminatory may nonetheless avoid being declared null and void where the government is able to overcome the presumption of invalidity ‘by showing that the statute is a “compensatory tax” designed simply to make interstate commerce bear a burden already borne by intrastate commerce.’” The court remanded the matter to the Court of Common Pleas of Montgomery County to hold a hearing and issue an “interim report” on whether the stock clause was a compensatory tax. Montgomery County President Judge Joseph A. Smyth issued an interim report in October 1998, ruling that the portion of the stock clause which excludes from the personal-property tax stock held in companies which are subject to the capital stock and franchise taxes is unconstitutional. But Smyth said the high court need not strike down the statute in its entirety, because the language of the statute that made it constitutionally offensive could be severed, leaving a personal-property tax which applied to all classes of stock, whether they are held in in-state or out-of-state corporations. That having been said, Smyth also recommended that the counties should be able to keep the tax which had been previously collected under the stock clause. “At arriving at this conclusion, President Judge Smyth stated that once the unconstitutional exclusion was severed from the stock clause, leaving a tax which was applicable to stock held in either out-of-state or in-state entities, then a valid tax remained; President Judge Smyth reasoned that in that event, the ‘counties should be permitted to retain and collect the personal property tax on stock that is not subject to the capital stock or franchise taxes.’” In the opinion handed down last week, the high court accepted most of Smyth’s recommendations. COMPENSATORY TAX REJECTED For a tax to be considered a valid compensatory tax, the state must establish three things, the court said. The government must identify the intrastate tax burden for which the facially discriminatory tax is compensating. The government must show that the tax on interstate commerce approximates, but does not exceed, the amount of the tax on intrastate commerce. The government must show that the events on which the interstate and intrastate taxes are imposed must be substantially equivalent. “The three prong Fulton test is stated in the conjunctive; thus failure to meet one of any of the three prongs results in a finding that the governmental entity has failed to meet its burden in establishing that the discriminatory tax is nonetheless valid as a compensatory tax,” the court said. The counties claimed that the stock clause is part of a comprehensive taxing scheme established to compensate for the taxes exacted by the capital stock and franchise taxes. The court rejected that argument, finding the legislative history of the personal-property tax law did not support it. “President Judge Smyth concluded that history shows that these taxes ‘developed independent of each other through their histories … [and that] at no time was there a correlation between the taxes,” the court noted. The court adopted Smyth’s finding on this point. The court said it also rejected the argument because the counties did not establish that the stock clause tax is fairly related to the services provided by the counties which benefit interstate commerce, a requirement under the first prong. The court continued that even if it concluded the counties satisfied the first prong, they could not have met their burden as to the remaining two prongs of the Fulton test. The court said it was not persuaded by the counties’ expert witness’ testimony that the tax imposed by the facially discriminatory stock clause “roughly approximates, but does not exceed” the amount of the tax burden which the capital stock tax and the franchise tax impose. And with regard to the third prong, the court adopted Smyth’s conclusion that the personal-property tax is not substantially equivalent to the capital stock and franchise taxes. Smyth had credited the Annenbergs’ witness’ testimony that the personal-property tax is based on the value of shares on one day, while the capital stock and franchise taxes are determined by measuring economic flow. In addition, the personal-property tax is imposed at the county level and is used for county purposes, whereas the capital stock and franchise taxes are imposed at the state level and are used for state purposes. Because the counties failed to establish that the tax was a compensatory tax, the court ruled that “the portion of the stock clause which excludes from the personal-property tax stock held in companies which are subject to the capital stock and franchise taxes is unconstitutional.” But that did not end the court’s inquiry. In the next step of the analysis, the court concluded the exclusionary language in the stock clause that makes it unconstitutional could be severed. EXCISING THE UNCONSTITUTIONAL The Annenbergs had argued that the clause could not be severed and that the personal-property tax on stock must be stricken in its entirety. “In support of their argument, they point to the fact that the legislature has recently rejected a proposed bill which included a provision which would have extended the personal-property tax to all classes of stock,” the court said. “The Annenbergs claim that when the legislature rejected this proposed bill, it sent the clear message that it did not desire the stock clause of the personal-property tax to apply to all classes of stock.” The court rejected that argument. The court said only a “miniscule portion” of the rejected bill concerned the stock clause of the personal-property tax. Therefore, without evidence of the legislative intent in rejecting the bill, the court said it would not infer that the stock clause was the reason. “Second, and far more importantly, the Annenbergs’ argument is inapt as it requests that we focus not on the intent of the legislature which enacted the void provision of this statute, but rather on the intent that can possibly be inferred from the rejection of a bill by a legislative body more than 100 years after the statute was enacted.” The court said that analysis was not in accord with the rules of statutory construction, concluding the void provision is severable. “The net effect of this severance is that stock which had previously escaped the personal property tax due to the fact that the companies in which that stock was held owed either the corporate stock or franchise taxes will now be subject to the personal property tax,” Zappala said. THE REMEDY The court then turned its analysis to determining what retrospective remedy, if any, was proper. Smyth had recommended in his interim report that the counties not be required to give a refund of the taxes paid by the Annenbergs under the stock clause. “The net effect of President Judge Smyth’s recommendation would be that the status quo for prior taxing years would be maintained: the tax which had been previously collected would be retained by the counties, but the tax would not be retroactively collected on stock held in companies which had been subject to the capital stock or franchise tax,” the court said. “Furthermore, the expanded tax which resulted from severing the void provision from the stock clause would apply only to future tax years.” The court rejected that option, finding the U.S. Supreme Court’s decision in McKesson v. Division of Alcoholic Beverages and Tobacco required a different result. Under McKesson, “the state [must] provide meaningful backward-looking relief to rectify any unconstitutional deprivation,” the court said. Essentially, McKesson requires Montgomery and the other counties to put those taxpayers who paid the tax in the same position as those taxpayers who had been favored by the unlawful exemption. The McKesson court “did not bind the state’s hands in choosing what type of backward looking remedy it would employ,” the court said. According to McAlee, the county can choose any remedy that “evens the playing field.” A remedy may involve taxing those individuals who had not been taxed before; refunding the tax to those taxpayers who were subject to the discriminatory tax; or anything in between, such as tax credits for future years. “Each county will have to make its own decision,” McAlee said, noting that each county’s situation is unique. Different counties stopped imposing the tax in different years, so no two counties are in exactly the same situation, he said. The Annenbergs had argued that once the court made a determination that as a matter of constitutional law they are entitled to a remedy, then only one type of remedy is allowed — a full refund of the money they paid pursuant to the stock tax. But the court rejected that argument. “We have not concluded that the counties are not legally entitled to levy a personal property tax on corporate stock holdings,” the court said. “By severing the exclusionary language in the stock clause which renders the stock clause unconstitutional, we have left intact the counties’ ability to levy a personal property tax on corporate stock holdings generally.” Therefore, the court said, the tax levied by Montgomery County on the Annenbergs’ corporate stock holdings constituted a tax to which the county was legally entitled. Thus, the Pennsylvania statute mandating a refund of taxes to which the government is not entitled — 72 P.S. Section 5566b — does not apply, the court held. It is with this aspect of the majority’s decision that Justices Ralph Cappy and Russell Nigro disagreed. DISSENT “I believe that the reasoning espoused by the majority is internally inconsistent,” Cappy wrote for the dissent. “First the majority finds that the stock clause violates the Commerce Clause. … And yet, the majority paradoxically proceeds to hold that the counties were nonetheless legally entitled to collect this tax, and the provisions of [Section 5566b] therefore do not apply. With all due respect, I simply cannot fathom how the majority can logically conclude both that a tax was unconstitutionally collected and that the counties were legally entitled to collect that very same tax.” Cappy said he would have granted the Annenbergs a full refund.

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