United States: PA Shares Tax: Disparate Treatment Of Bank Mergers Ruled Constitutional

On December 27, 2013, in Lebanon Valley Farmers Bank v. Commonwealth of Pennsylvania, No. 78 MAP 2011 (Pa. December 27, 2013), the Pennsylvania Supreme Court held that a bank formed from the merger of an in-state bank and an out-of-state bank may be subject to lower Shares Tax liability than a bank formed from the merger of two in-state banks. The Court ruled that the Pennsylvania Shares Tax's "combination provision," 72 P.S. §7701.1(c)(2), is not a violation of the Pennsylvania Constitution's Uniformity Clause, notwithstanding that under certain circumstances, it may result in a lower tax burden in the context of an out-of-state bank merger than an in-state bank merger.

The Shares Tax

The Shares Tax is imposed on every banking institution conducting business in Pennsylvania that has shares of capital stock.  The Shares tax has three relevant provisions to this case.  First, the calculation of the tax is based on the six-year average book value of the bank's net assets.  Second, the tax is only imposed upon "institutions," which includes any bank incorporated under Pennsylvania law or is located in Pennsylvania. 72 P.S. §7701.5.  Third, the "combination provision" provides that in a combination or merger, the surviving entity shall be treated as if it had been "a single institution in existence prior to as well as after the combination and the book values . . . of the constituent institutions shall be combined." 72 P.S. §7701.1(c)(2).

Taxpayer's Argument

In 2005, the appellant Pennsylvania bank filed a petition with the Pennsylvania Board of Appeals, seeking a refund of the portion of its 2002 Bank Shares Tax payment attributable to one of the pre-merger bank's share value.  The appellant, which merged with another Pennsylvania bank, argued that under the Commonwealth Court's interpretation of the combination provision, as set forth in First Union Nat'l Bank v. Commonwealth, 867 A.2d 711 (Pa. Commw.Ct.), exceptions dismissed, 885 A.2d 112 (Pa. Commw. Ct. 2005), aff'd per curiam, 901 A.2d 981 (Pa. 2006), a merger of two in-state banks could result in substantially higher tax liability than the liability arising from an in-state bank's merger with an out-of-state bank, because the combination provision is inapplicable when mergers involve out-of-state banks, thus violating the Uniformity Clause.  After the Board of Appeals and the Commonwealth Court rejected the petition, the appellant appealed to the Pennsylvania Supreme Court.

Pennsylvania's Uniformity Clause, Pa. Const. art. VIII, §1, requires all taxes to be uniform upon the same class of subjects.  The Court in Lebanon Valley Farmers Bank treated the two types of mergers as members of the same class for purpose of the Uniformity Clause.

The Pennsylvania Supreme Court's Holding

The Court concluded that the pre-merger book value of an out-of-state bank is not included in the surviving institution's historical averaging calculation to determine its current value for purposes of computing its tax liability.  The Court held that the Shares Tax's combination provision does not apply to a combination of a Pennsylvania bank and an out-of-state bank because an out-of-state bank is not an "institution" under the statute.   The Court held when a Pennsylvania bank merges with an out-of-state bank, the out-of-state bank's pre-merger assets are not accounted for in the post-merger bank's six-year average value calculation under Pennsylvania's Shares Tax, 72 P.S. §§7701-7706; and, when two in-state banks merge, the pre-merger value of both banks are included in the post-merger bank's six-year average value.

The Court found that while this may result in unequal tax burdens – an out-of-state merger may be subject to a lower tax liability than an in-state merger – the Court justified the disparity on the basis that the out-of-state bank's assets were not previously subject to Pennsylvania state tax.  Thus, unlike an in-state merger, an out-of-state merger "enriches the public coffers" by "the adding of assets to the reach of Pennsylvania's tax law[.]"  Therefore, the Court ruled, "[t]his 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."  "The merger or combination 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."

In his dissent, Justice Saylor noted "that the Bank Shares tax's combination provision violates tax uniformity insofar as it has been interpreted to exclude out-of-state banks."  Justice Saylor found the majority's justification "difficult to support," and maintained that the distinguishing circumstance identified by the majority of the Court was arbitrary, and "that it is unclear whether [the majority's] factual premise can withstand scrutiny."

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