IN THE COMMONWEALTH COURT OF PENNSYLVANIA

John Thompson, : Petitioner :

:

v. : No. 188 F.R. 2016

: Argued: June 6, 2018 Commonwealth of Pennsylvania, : Respondent :

: Commonwealth of Pennsylvania, : Petitioner :

:

v. : No. 215 F.R. 2016

: Argued: June 6, 2018 John Thompson, : Respondent :

BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge

HONORABLE RENÉE COHN JUBELIRER, Judge HONORABLE P. KEVIN BROBSON, Judge HONORABLE PATRICIA A. McCULLOUGH, Judge HONORABLE ANNE E. COVEY, Judge HONORABLE MICHAEL H. WOJCIK, Judge HONORABLE ELLEN CEISLER, Judge

OPINION NOT REPORTED

MEMORANDUM OPINION BY JUDGE BROBSON FILED: November 2, 2018

This is one of several related matters, challenging the assessment of

Pennsylvania personal income tax (PIT) liability on nonresident investors on account

of the 2005 foreclosure of a commercial property located in the City of Pittsburgh

(Property) . We resolved the first round of appeals through en banc opinions and2

orders issued in 2012, which the Pennsylvania Supreme Court affirmed in Wirth v.

Commonwealth , 95 A.3d 822 (Pa. 2014), cert. denied sub nom. Houssels v.

Pennsylvania , 135 S. Ct. 140 5 (2015). 1 Petitioner John Thompson (Taxpayer), a

resident of the State of Texas, is among the second round of challengers. 2

In a decision dated February 24, 2016, the Board of Finance and

Revenue (Board) assessed Taxpayer’s PIT liability on account of the foreclosure of

the Property at $102,952

, “plus appropriate interest, less any payments and credits

to his account.” Both Taxpayer and the Pennsylvania Department of Revenue

(Department) challenge aspects of the Board’s decision. We affirm.

I. BACKGROUND 3

600 Grant Street Associates Limited Partnership (Partnership),

organized under Connecticut law, purchased the Property for $360 million. Of this

$360 million purchase price, the Partnership financed $308 million with a Purchase

Money Mortgage Note (PMM Note) secured only by the Property. The PMM Note

was nonrecourse, meaning that the Partnership and the lender agreed that the

lender’s only recourse for nonpayment of the obligations under the PMM Note was

to pursue foreclosure of the Property. As the na me of the Partnership suggests, the

Partnership’s primary purpose was the ownership and management of the Property.

1 Our lead opinion disposing of those earlier appeals was Marshall v. Commonwealth

, 41 A.3d 67 (Pa. Cmwlth.) (en banc) ( Marshall I ), exceptions overruled , 50 A.3d 287 (Pa.
Cmwlth. 2012) (en banc), aff’d sub nom. Wirth v. Commonwealth , 95 A.3d 822 (Pa. 2014), cert. denied sub nom. Houssels v. Pennsylvania , 135 S. Ct. 140 5 (2015).

2 Others in the second round include Craig S. and Christine L. Andrews (Docket

Nos. 185, 212 F.R. 2016), Ronald S. Leventhal (Docket Nos. 186, 213 F.R. 2016), and Annette Sharp e (Docket Nos. 187, 214 F.R. 201 6 ).

3 The background is drawn from the p arties’ Joint Stipulation of Facts (Stipulation) and accompanying exhibits, which we adopt as our findings of fact in this de novo tax appeal. In so doing, we note that the Stipulation is largely consistent with the facts as found by this Court in
Marshall I

.3 Interest on the PMM Note accrued on a monthly basis at a rate

of 14.55%. If the monthly accrued interest exceeded the net operating income of the

Partnership, the Partnership was not required to pay the excess ( i.e. , the amount of

monthly accrued interest less monthly net operating income). Instead, the accrued

but unpaid excess would be deferred and, thereafter, compounded on an annual basi s
subject to the same interest rate as the principal amount of the PMM Note. The

original maturity date of the PMM Note was November 1, 2001. In 1998, the lender

and the Partnership amended the PMM Note to extend the maturity date to

January 2, 2 005.

Tax payer purchased a limited partnership interest ( 1 unit ) in the

Partnership on or about December 31, 1984 , for $ 148,889

. His 1 unit interest

amounted to a 0. 151281 % interest in the Partnership. Taxpayer was a passive

investor. He never participated in th e management of the Partnership or the

Property.

Over the years, the Partnership’s net income from operations did not

keep pace with projections. The Partnership incurred losses from operations for

financial accounting, federal income tax, and PIT purpose s every year of its

existence. For PIT purposes, the Partnership allocated its annual losses from

operations to each partner, including Taxpayer. Taxpayer filed Pennsylvania PIT

returns for tax years 1985 through 2005, reporting thereon his pass

- through share 4

4 Under Section 306 of the Tax Reform Code of 1971 (Code), Act of March 4, 1971, P.L. 6,
as amended

, added by the Act of August 31 , 19 71 , P.L. 362 , 72 P.S. § 730 6, partnerships as legal entities are not subject to PIT. Rather, the partners of the partnership pay PIT on their respective shares of the partnership’s income or gain. Section 306 of the Code provides:

Except as provided under section 306.2 [ of the Code, added by the Act of July 9, 2013, P.L. 270, 72 P.S. § 7306.2], a partnership as an entity shall not be subject to the tax imposed by this article, but income or gain of a member of a4

of the Partnership losses “derived from or in the form of rents, royalties, patents and

copyrights,” which is one of eight separate classes of income subject to PIT under

Section 303 of the Code. 5 In these tax years, Taxpayer had no offsetting inco me of

the same class.

Because of the Partnership’s dismal operations, the Partnership paid

less monthly interest on the PMM Note than it had projected. Under the terms of

the PMM Note, this led to a greater amount of accrued but unpaid interest over the

y ears. According to the comprehensive “ Offering Memorandum ” shared with

investors , the Partnership projected accrued but unpaid interest on the PMM Note at

maturity (November 1, 2001, later extended to January 2, 2005) to be approximately

$300 million. It also projected that proceeds upon sale of the Property at maturity

would be sufficient to pay off the principal and accrued interest on the PMM Note,

with excess funds available to distribute to the partners as a return on their

investment. At the date of foreclosure, the Partnership had an accrued but unpaid

interest obligation of approximately $2.32 billion. The Partnership had used

approximately $121,600,000 of this amount to offset its income from operations that

would otherwise have been subject to PIT. Neither the Partnership nor Taxpayer

derived any PIT benefit from the remainder.

The lender foreclosed on the Property on June 30, 2005. By that time,

what began as a $308 million Partnership liability on the PMM Note had grown into

partnership in respect of said partnership shall be subject to the tax and tax shall be imposed on his share, whether or not distributed, of the income o r gain received by the partnership for its taxable year ending within or with the member’s taxable year.

5 Act of March 4, 1971, P.L. 6, as amended

, added by the Act of August 4, 1991, P.L. 97, 72 P.S. § 730 3

. Specifically, Section 303(a)(4) of the Code p rovides for a class of income encompassing “[n]et gains or income derived from or in the form of rents, royalties, patents and copyrights.”5

a liability of more than $2.6 billion, of which only $308 million represented

principal. Neither the Partnership nor its individual limited partners received any

cash or other p roperty as a result of the foreclosure. That same year, the Partnership

terminated operations and liquidated. Taxpayer did not recover his capital

investment in the Partnership at foreclosure or liquidation. Indeed, Taxpayer did not

receive any cash or other property upon liquidation of the Partnership.

The Partnership reported a gain on foreclosure of the Property for tax

year 2005 on federal Form 1065 and Pennsylvania Form PA

- 65 (information return),

the overwhelming majority of which is attributable t o the full amount of the PMM

Note debt obligation (principal plus accrued but unpaid interest) discharged upon

foreclosure. The Partnership reported to Taxpayer on Pennsylvania Schedule

NRK

- 1 for tax year 2005 his pass

- through share of the Partnership gai n, $ 3,764,028

, in the class of “[n]et gains or income from the disposition of property.”

Section 303(a)(3) of the Code. 6 It also reported to Taxpayer his pass

- through share

of the Partnership’s operating losses that year as Section 303(a)(4) class income

.

6 Section 303(a)(3) of the Code is quite lengthy. The general class description provides:

Net gains or income from disposition of property. Net gains or net income, less net losses, derived from the sale, exchange or other disposition of property, including real property, tangible personal property, intangible personal property or obligations issued on or after the ef fective date of this amendatory act by the Commonwealth; any public authority, commission, board or other agency created by the Commonwealth; any political subdivision of the Commonwealth or any public authority created by any such political subdivision; o r by the Federal Government as determined in accordance with accepted accounting principles and practices.

In addition to providing this general description of the class, the General Assembly also expressly exempted several specific transactions from the c lass. See 72 P.S. § 7303(a)(3)(iii)

- (vii). None of these exceptions, however, apply to the particular type of property disposition in this case.6 In a Notice of Assessment dated May 9, 200 8, the Department assessed

Taxpayer $ 115,556 in PIT liability, plus penalties and interest of $ 5 0 ,09 4

. 16 , for a

total assessment of $ 166,520.16 (Assessment). In doing so, the Department

determined that Taxpayer had a taxable gain from the foreclosure for PIT purposes

in the amount of his pass

- through share of the gain reported by the Partnership in its

informational filing

— $ 3

, 764

, 028 . Taxpayer filed a petition for reassessment with

the Department’s Board of Appe als (BOA), challenging the Assessment . On

August 24 , 2015, 7 BOA rejected the majority of Taxpayer’s arguments. It,

nonetheless, abated the assessed penalties in full and recalculated the amount of gain

realized by the Partnership upon disposition of the Property, accounting for annual

straight

- line depreciation of the Property dating back to the year the Partnership

acquired it. 8 Taxpayer’s pass

- through share of the Partnership’s revised gain was

$ 3

, 635 ,7 96 , thereby reducing Taxpayer’s principal PIT liab ility from $ 115,556 to

$ 111,619 . The Department issued a Notice of Reassessment (Reassessment)

consistent with BOA’s determination.

Taxpayer appealed the Reassessment to the Board . Citing Wirth

, Taxpayer contended that the tax benefit rule should be appl ied to exclude from the

amount of the gain realized by the Partnership upon foreclosure that amount of prior

year operating losses attributable to accrued b ut unpaid interest deductions for which

the Partnership derived no tax benefit. Under Taxpayer’s view, this would reduce

7 BOA stayed consideration of Taxpayer’s petition pending the Pennsylvania Supreme
Court’s decision in Wirth

.

8 As this Court noted in Marshall I , a gain for PIT purposes is recognized “where the amount realized from the disposition of the property exceeds the adjusted basis of the property at the time of disposition.” Marshall I , 41 A.3d at 81. Further, deprec iation, allowed or allowable, is one of the factors that determines the adjusted basis of property at disposition. Depreciation reduces the basis of the property.7

the amount realized by the Partnership from $2.6 billion to just $429,600,000,

reducing the taxable gain for the Partnership from $2,362,812,499 to

just $163,914,9 48. Concomitantly, Taxpayer’s PIT liability for his pass

- through

share of the Partnership’s taxable gain would be reduced by approximately 93%.

Taxpayer also challenged BOA’s determination that the Partnership

was required to reduce its basis in the P rope rty by straight

- line depreciation dating

back to the year that the Partnership acquired the Property. Section 303(a.2) was

added to the Code by section 9 of Act 89 of 2002. 9 Section 34 of Act 89 of 2002

provides that Section 303(a.2) of the Code “shall a pply to taxable years beginning

after December 31, 2000.” Taxpayer argued that this language meant that the

minimum straight

- line depreciation provision should only be applied for tax

years 2001 and thereafter and, therefore, did not mandate a minimum dow nward

basis adjustment for straight

- line depreciation in years preceding the 2001 tax year.

The Department offered a competing interpretation. In its view, Section 303(a.2) of

the Code relates to the calculation of income. In this case, the income in qu estion is

the gain on disposition of the Property, which occurred in 2005. Accordingly,

because the income event occurred after the effective date of Section 303(a.2), the

minimum straight

- line depreciation provision applied to calculate the adjusted basi s
of the Property from inception through foreclosure and, consequently, any gain upon

disposition.

Taxpayer also argued that Pennsylvania lacks the authority to impose

PIT liability on Taxpayer in this case, because doing so would violate the Commerce

Clau se of the United States Constitution. 10 Taxpayer also contended that, in reality,

9 Act of June 29, 2002, P.L. 559.

10 U.S. Const. art. I, § 8, cl. 3 (conferring on Congress power “[t]o regulate Commerce . . . among the several States”).8

he did not experience a taxable gain in 2005 and

, therefore, should not have to pay

PIT, citing Commonwealth v. Rigling , 409 A.2d 936 (Pa. Cmwlth. 1980). Finally,

in a concl usory paragraph, Taxpayer cited a litany of state and federal constitutional

violations and requested attorney’s fees pursuant to 42 U.S.C. §§ 1983 and 1988.

The Board granted Taxpayer’s request for relief from the Reassessment

in part and denied it in par t. The Board revised downward the amount of gain

realized by the Partnership, agreeing with Taxpayer that the Partnership was not

required to reduce its basis in the P roperty by straight

- line depreciation until the

2001 tax year. Consequently, the Board revised downward Taxpayer’s pass

- through

share of the Partnership’s gain to $ 3

, 353,492 , thereby reducing Taxpayer ’ s principal

PIT liability to $ 102,952 . The Board, however, rejected Taxpayer’s other challenges

to the Reassessment. Taxpayer now appeal s th e Board’s re jection of his tax benefit

rule and Commerce Clause arguments , and the Department appeals the Board’s

interpretation and application of Section 303(a.2) of the Code , relating to

straight

- line depreciation

. 11

II. DISCUSSION

This Court adequately addressed all of the issues in this appeal in our

opinion in Andrews v. Commonwealth , ___ A.3d ___ ( Pa. Cmwlth.,

No s

. 185, 212 F.R. 20 16, filed _____________, 2018) . We incorporate that opinion

by reference and reach the same conclusions in this case.

11 Our standard of review in this matter is covered by Rule 1571 of the Pennsylvania Rules of Appellate Procedure

. “Appeals taken from the Board of Finance and Revenue are de novo in nature, with no record being certified by the board.” Tool Sales & Serv. Co. v. Bd. of Fin. &

Revenue

, 637 A.2d 607, 610 ( Pa. 1993), cert. denied sub nom. Tom Mistick & Sons, Inc. v.

P a. , 513 U.S. 822 (1994). “Although the Court hears the se cases under its appellate jurisdiction, the Court functions essentially as a trial court.” Scott Elec. Co. v. Commonwealth

, 692 A.2d 289, 291 (Pa. Cmwlth. 1997), exceptions dismissed

, 704 A.2d 205 (Pa. Cmwlth. 1998).9 III. CONCLUSION

For the reasons set forth above, we affirm the Board’s assessment of

Taxpayer’s PIT liability in all respects.

P. KEVIN BROBSON, Judge

Judge Fizzano Cannon did not participate in the decision of this case.IN THE COMMONWEALTH COURT OF PENNSYLVANIA

John Thompson, : Petitioner :

:

v. : No. 188 F.R. 2016

: Commonwealth of Pennsylvania, : Respondent :

: Commonwealth of Pennsylvania, : Petitioner :

:

v. : No. 215 F.R. 2016

: John Thompson, : Respondent :

O R D E R

AND NOW, this 2 nd day of November , 2018, the order of the Board of

Finance and Revenue is AFFIRMED.

Unless exceptions are filed within 30 days pursuant to

P a. R.A.P. 1571(i), this order shall become final.

P. KEVIN BROBSON, JudgeIN THE COMMONWEALTH COURT OF PENNSYLVANIA

John Thompson

, :

Petitioner :

: No. 18 8 F.R. 201 6

v. :

: Com monwealth of Pennsylvania, :

Respondent :

Commonwealth of Pennsylvania, :

Petitioner :

: No. 21 5 F.R. 2016

v. :

: Argued: June 6, 2018 John Thompson

, :

Respondent :

BEFORE: HONORABLE MARY HANNAH LEAVITT, President Judge

HONORABLE RENÉE COHN JUBELIRER, Judge HONORABLE P. KEVIN BROBSON, Judge HONORABLE PATRICIA A. McCULLOUGH, Judge HONORABLE ANNE E. COVEY , Judge HONORABLE MICHAEL H. WOJCIK, Judge HONORABLE ELLEN CEISLER, Judge

OPINION NOT REPORTED

CONCURRING OPINION BY JUDGE McCULLOUGH FILED: November 2, 2018

I join in the Majority’s affirmance of the Board of Finance and

Revenue’s application of section 303(a.2) of the Tax Reform Code of 1971 1

1 Act of March 4, 1971, P.L. 6, as amended , added by the Act of June 29, 2002, P.L. 559, 72 P.S. §7303(a.2).PAM

- 2

concerning minimum straight

- line depreciation. However, I concur with the

Majority’s affirmance of the Board’s refu sal to apply the tax benefit rule to reduce

the personal income tax (PIT) liability of John Thompson , for the reasons set forth

in my Concurring Opinion in Marshall v. Commonwealth of Pennsylvania , ___ A.3d

___ (Pa. Cmwlth., Nos. 863 F.R. 2015 and 50 F.R. 2016, filed November 2, 2018 ).

________________________________ PATRICIA A. McCULLOUGH, Judge