Court Opinion

ID: 4965567
Source: CourtListenerOpinion
Date Created: 2021-09-24 16:16:09.470704+00
Date Added: 2024-06-11T08:16:07.126004
License: Public Domain

DISSENTING OPINION BY
Judge McCullough.
This case is one of first impression and presents important issues concerning the consequences of a substantial write-off of nonrecourse financing under the Pennsylvania personal income tax (PIT) provisions of the Tax Reform Code of 1971 (Code), Act of March 4, 1971, P.L. 6, as amended, 72 P.S. §§ 7301-7361, or as constitutional issues of equal protection and uniformity vis-a-vis resident and non-resident taxpayers. While the Majority expended considerable effort in interpreting the tax implications of this case, I must dissent. I do not agree that the amount realized by this nonresident taxpayer for purposes of assessing the PIT from the foreclosure of what originally was a $308 million loan was his pro rata share of more than $2 billion, since that conclusion does not square with the plain meaning and strict construction of the PIT nor with the economic realities of this matter. I also do not believe that this case needs to be remanded since we sit de novo and can direct the parties to supplement the record to tie up any loose ends.
The parties, Petitioner Robert J. Marshall, Jr. (Marshall) and the Commonwealth of Pennsylvania (Commonwealth), Respondent, have stipulated to a series of facts that frame the issues before the Court and we summarize these facts below. 600 Grant Street Associates Limited Partnership (Partnership) purchased the property for $360 million, including $52 million in cash. (Joint Stipulation of Facts (Stipulation), No. 26.) The Partnership financed the remainder through a Purchase Money Mortgage Note (PMM Note) with an initial principal balance of $308 million, secured only by the subject property (Property). Id. Marshall later purchased a limited Partnership interest for $5,889 in cash and a promissory note in the amount of $143,000 that amounted to 0.151281% of the Partnership. (Stipulation, No. 13.) In 2005, the lender initiated *99foreclosure proceedings on the property. (Stipulation No. 35.)
At that time, the outstanding balance on the PMM Note was approximately $2.6 billion, the bulk of which consisted of accrued but unpaid interest. (Stipulation, No. 37.) The Partnership utilized approximately $121.6 million of the accrued but unpaid interest to offset income from operations that otherwise would have been subject to PIT. (Stipulation, No. 38.) The Department of Revenue (Revenue) thereafter assessed Marshall, a resident of Texas, a PIT of $165,055.25, representing principal, interest and penalties for the 2005 tax year. (Stipulation, No. 1.)
It is without dispute that Marshall lost his entire investment, as did the other limited partners who invested in the Partnership, be they residents or nonresidents. Nonetheless, Revenue’s PIT assessment, including penalty and interest, exceeds the amount of Marshall’s investment. Revenue attempts to justify this apparently incongruous determination by claiming that the Partnership (not Marshall, who as a limited partner was insulated as a matter of law from Partnership liability) realized income in the nature of a discharge of indebtedness in the amount of the aforesaid $2.6 billion, although this was a non-recourse obligation as to even the Partnership itself. Moreover, the original principal amount of the obligation ($308 million) is but a fraction of the total obligation, as unpaid interest was accrued, compounded, and added to the principal.
If Marshall’s argument that because no cash or property was actually received by the Partnership as a result of the disposition of the property and, hence, there was no amount realized or gain is accepted, the Commonwealth claims that the PIT “has a huge hole built right into it” that would allow the use of “debt discharge,” $2.6 billion in this instance, “to avoid the [PIT].” (Commonwealth’s Brief at 10.)
Revenue has determined Marshall’s distributive share of the discharged debt to be $3,976,417. The Commonwealth relies on Commissioner of Internal Revenue v. Tufts, 461 U.S. 300, 103 S.Ct. 1826, 75 L.Ed.2d 863 (1983), in support of its argument, and the Majority relies on this case as well in support of its decision. Tufts and its predecessor, Crane v. Commissioner, 331 U.S. 1, 67 S.Ct. 1047, 91 L.Ed. 1301 (1947), established the notion that, for federal income tax purposes, the unamortized principal amount of a nonrecourse loan is to be included in the amount realized from a sale or disposition of the real estate.
The Majority proceeds to conclude that as a consequence of the foreclosure, there has been an “amount realized upon the disposition of the Property,” and in reliance upon Tufts, the amount realized must at a minimum include the principal amount of the PMM note that the Partnership used to purchase the Property. The Majority also relies on a decision from the Eighth Circuit, Allan v. Commissioner of Internal Revenue, 856 F.2d 1169, 1173 (8th Cir.1988), holding that “the amount realized is the full amount of the nonrecourse liabilities which are discharged as a result of the transfer of the property,” to support its conclusion that the accrued but unpaid interest on the PMM Note (approximately $2.3 billion) should be included in the amount realized as well as to support its remand to the Board of Finance and Revenue (Board) for the determination of the applicable adjusted basis.
Marshall also raises issues under the United States and Pennsylvania Constitutions related to his alleged disparate treatment as a non-resident taxpayer with respect to the treatment for PIT purposes of the loss realized from the dissolution of the Partnership subsequent to the foreclosure. *100While the resident taxpayers have the benefit of using this loss to shelter a substantial portion of the gain attributed by the foreclosure, Marshall as a non-resident does not. Instead, this loss is out-sourced to his state of domicile, Texas. Nevertheless, the Majority rejects Marshall’s constitutional claims.
I, disagree with the Majority’s reasoning and conclusions for the reasons set forth below.
I. THE PIT DOES NOT APPLY TO INCOME IN THE NATURE OF A DISCHARGE OF INDEBTEDNESS AND THE MAJORITY’S RELIANCE UPON TUFTS AND ALLAN IS INCORRECT.
A. The PIT does not apply to income in the nature of a discharge of indebtedness.
The Majority takes great pains to analogize the PIT to the federal income tax in order to rationalize the foreclosure of the property as income. To do so, the Majority largely adopts the Commonwealth’s argument that the foreclosure and subsequent discharge of indebtedness constitutes a taxable sale or disposition of property. This argument is based upon the premise that the PIT “must” apply to discharges of indebtedness; otherwise, the PIT “has a huge hole....” (Brief of Commonwealth at 10.) Initially, whether or not, as the Commonwealth contends, the PIT has a “huge hole” if taxpayers could use “debt discharge ... to avoid the [PIT]” is subject to debate and, in any event, the argument clearly suggests that it is the role of the judiciary in the first instance to correct legislative deficiencies only because of a perceived benefit to taxpayers.
The role of the judiciary is prescribed not only by 1 Pa.C.S. § 1921(b) (when the words of a statute are clear and free from all ambiguity, the letter of it is not to be disregarded under the pretext of pursuing its spirit), but also by 1 Pa.C.S. § 1928(b)(3) (provisions imposing taxes shall be strictly construed). Hence if there is a “hole” or other error in a statute, particularly one involving a statute concerning taxes, it is up to the General Assembly in the first instance to address the matter. See Clifton v. Allegheny County, 600 Pa. 662, 969 A.2d 1197 (2009) (Supreme Court, exercising judicial restraint, declined to invalidate the base year property tax assessment statutes noting that the General Assembly is the appropriate place in the first instance to fashion a more comprehensive and soundly constitutional scheme).
As the Majority notes, the PIT identifies eight separate classes of income subject to the PIT, all of which it must be noted are taxed at the same rate. Nowhere in any of the eight categories is the discharge of an indebtedness identified as income. Moreover, section 302 of the Code is clear that the PIT applies only to those eight income categories.
The federal income tax is clearly and notably different. Unlike section 302 of the Code, section 61(a) of the Internal Revenue Code (IRC), 26 U.S.C. § 61(a) defines “gross income” as “all income from whatever source derived” and specifically includes “[fincóme from discharge of indebtedness” as gross income. See Section 61(a)(12) of the IRC, 26 U.S.C. § 61(a)(12). There is simply not a similar provision under the PIT provisions of the Code. Accordingly, taxation of the foreclosure of the property and subsequent discharge of indebtedness simply is not supportable. Our Rules of Statutory Construction oblige this Court to reach that very obvious conclusion. 1 Pa.C.S. § 1928(b)(3) (provisions of statute imposing taxes shall be strictly *101construed). If this renders a “huge hole” in the PIT, then it is up to the General Assembly to plug it.1
B. The Majority’s reliance upon Tufts and Allan is incorrect.
Given that the PIT does not apply to income derived from a discharge of indebtedness, which is the central underpinning of Revenue’s assessment of the PIT on Marshall, it cannot be seen how the Supreme Court’s 1988 decision Tufts or the Eighth Circuit’s 1988 decision in Allan support the Majority’s conclusion that the amount realized from the foreclosure of the property exceeds $2.6 billion, of which more than $2 billion is, in reality, accrued and compounded interest.
It must be noted that Tufts, though a decision of the United States Supreme Court, dealt with a specific provision of the I.R.C., Section 1001 (26 U.S.C. § 1001), and not any provision of the PIT. The same is the case with Allan. Consequently, neither of these decisions is binding upon this Court as precedent and these decisions have utility only to the extent one wishes to use them as references. It is noteworthy that in her concurring opinion in Tufts, Justice Sandra Day O’Connor expressed her preference for “quite a different” approach if the Supreme Court were “writing on a clean slate” except for the decision in Crane. Tufts, 461 U.S. at 317, 103 S.Ct. 1826. Crane is the problematic 1947 decision by the United States Supreme Court that is factually quite apart from the case before us.
The PIT does not contain any provisions akin to Section 1001 of the I.R.C. In determining the amount realized from the sale or disposition of property, Section 1001(b) includes “any money received plus the fair market value of the property (other than money received)”. 26 U.S.C. § 1001(b). This phrase does not appear anywhere in the PIT. A similarly worded phrase does appear in section 103.13 of Revenue’s regulations, 61 Pa.Code § 103.13. Upon this basis, the Majority bootstraps Tufts and Allan to adopt Revenue’s interpretation that “other property” includes the total discharge of indebtedness resulting from the foreclosure of the Property. It is respectfully submitted that the analysis is incorrect, has no application to Marshall, and must be rejected.
First, nowhere in Revenue’s regulations is the term “other property” defined. Crane, which spawned Tufts and Allan, *102was decided 58 years prior to the subject foreclosure, Tufts was decided 25 years prior, and Allan 17 years prior. If Revenue believed this line of decisions defined “other property” in section 103.18 of its regulations, it had ample time to codify its position. Revenue should be bound by its protracted silence on the matter. See 1 Pa.C.S. § 1928(b)(3).
Second, neither Tufts nor Allan stand for the proposition that a discharge of nonrecourse indebtedness is “other property.” Rather, those decisions categorized the nonrecourse indebtedness at issue as “true loans,” i.e., the same as full recourse indebtedness, in order that the tax consequences of the transactions involved reflected the respective economic realities of each situation.
Tufts is factually distinct from the instant case, a point the Majority acknowledges to some extent. Tufts did not, as the Majority notes, address the issue of accrued interest rolled into principal. Instead, the taxpayers in Tufts were general partners who had the benefit of taking a substantial write-off against the basis in the subject property, a basis that was previously attributable to a nonrecourse loan. Nonetheless, the taxpayers were posturing to claim a tax loss due to the sale of the subject property to a third party who assumed the mortgage. There is absolutely no indication that the taxpayers in Tufts suffered any true or economic loss, whereas Marshall clearly has in the present case. Indeed, the Supreme Court noted in Tufts that to permit the taxpayer to claim a tax loss without any economic loss would be an “absurdity.” Tufts, 461 U.S. at 312-313, 103 S.Ct. 1826. Accordingly, and under those circumstances, the nonrecourse loan in Tufts was determined to be a “true loan.”
Nonetheless, reliance on Tufts still does not get the Majority where it needs to go to have more than $2 billion in accrued interest realized as gain. Instead, the Majority has to travel to Minnesota and the Eighth Circuit’s decision in Allan to find support for this notion. Again, leaving the limited referential value of that case aside, its facts are clearly distinguishable.
In Allan, it was the taxpayers who sought the determination that interest paid to the Department of Housing and Urban Development (HUD) after it assumed the defaulted nonrecourse mortgage and made a part of principal could be used to inflate their basis in the Property. Ironically, the Commissioner of Internal Revenue argued against that position.
In determining that the property tax and interest payments made by HUD on behalf of the taxpayers (which it was obliged to do as the insurer of the defaulted mortgage) were includable as principal, the Eighth Circuit noted that HUD was in fact out of pocket monies, for it was paying the carrying costs of the mortgage for “legitimate business reasons,” i.e., the hope that its loan would enable the taxpayers time to work out of its difficulties. Allan, 856 F.2d at 1173. Hence, the Court in Allan concluded that the HUD advances were part of a “true loan.” Id.
In the case before us, however, Marshall derived no economic benefit from a basis inflated by the roll-up of accrued interest, and the assessment of tax by Revenue is for ordinary income under the PIT, not some relatively favorable capital gains treatment. Unlike Allan, the nonrecourse lender is not a government entity that actually expended public monies to acquire a defaulted mortgage and pay carrying costs.
Indeed, the exorbitant amount of interest that has accrued as to the subject nonrecourse loan raises the issue as to whether the same can realistically be *103treated as a “true loan.” It is not at all realistic that the Partnership, which consisted of only one property of declining value in a tough real estate market, could be expected to satisfy the $2.6 billion obligation attached to it. Clearly, as this tremendous debt continued to accrue at a compounding rate, there was little if any incentive to do anything other than default, and one cannot imagine a lender not realizing this.
Under the circumstances presented to the Court, it cannot be seen how the “relief’ from this debt by virtue of foreclosure can be viewed as an economic benefit to Marshall since the only relief is abandonment of the property itself.2 Hence, the nonrecourse loan in this instance is akin to preferred stock because the lender has taken on so much risk of nonpayment due to the speculative nature of recovery of the principal and accrued and compounded interest thereon. To that end, there is extensive case law history of the IRS refusing to accept the form of so-called debt instruments as controlling and treating them instead as stock because of the speculative nature of recovery. See Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders, Section 4.05 (1979); see also Tufts, 461 U.S. at 307, n. 5, 103 S.Ct. 1826 (“The Commissioner might have adopted the theory, implicit in Crane’s contentions, that a nonrecourse mortgage is not true debt, but instead a form of joint investment by the mortgagor and mortgagee ... ”).
II. THE TAX BENEFIT RULE SHOULD BE APPLIED SO AS TO RECOGNIZE ECONOMIC REALITY.
In light of the foregoing considerations, the Court should evaluate the economic reality of this case. Marshall clearly lost his entire investment and he clearly did not realize an economic benefit anywhere near the more than $3 million Revenue attributes to him for PIT assessment purposes. He did, however, realize a benefit to the extent he was able to shelter income imputed to him, i.e., his fractional share of $121.6 million. Marshall clearly had a tax and economic benefit to that extent.
Application of the tax benefit rule should be applied so as to recapture Marshall’s otherwise sheltered income.3 While the tax benefit rule is not codified in Pennsylvania, it is clearly recognized by Revenue given the references to the rule and the discussion of its application in its PIT Guide, which in turn is published on the Department’s website and includes detailed instructions regarding, inter alia, pass through entities such as partnerships and the treatment of partnership losses. While the PIT Guide is not a statute or regulation and, hence, does not have the force of law, the PIT Guide was prepared *104by Revenue and, as the Majority states, sets forth a statement of policy which includes application of the tax benefit rule.4
Herein, the parties stipulated that the Partnership only used $121.6 million of accrued but unpaid interest to offset income from operations that otherwise would have been subject to PIT. (Stipulation, No. 38.) Application of Partnership interest in said $121.6 million, or $183,958 ($121.6 million x 0.151281%), would subject Marshall to PIT in the amount of $5,648 ($183,958 x 3.07%).5
III. MARSHALL RAISES A LEGITIMATE CONSTITUTIONAL CLAIM.
Finally, Marshall raises legitimate constitutional concerns at least as to the Uniformity Clause of the Pennsylvania Constitution which provides that all taxes shall be uniform upon the same class of subjects. Pa. Const, art. VIII, § 1. In this case, the Department permitted Pennsylvania resident limited partners in the Partnership to offset any taxable gain from the foreclosure of the property with the loss incurred upon liquidation of the Partnership. Nonresidents such as Marshall were denied this offset, even though the foreclosure of the property and the liquidation of the Partnership were parts of the same economic event occurring in this Commonwealth.
A resident and nonresident partner in the Partnership each exercised the same privilege in Pennsylvania by investing in the Partnership, and, hence, the tax burden placed on the nonresident partner should not exceed the burden placed on the resident partner. Indeed, our Pennsylvania Supreme Court has indicated that the Uniformity Clause of the Pennsylvania Constitution requires that a tax be applied with substantial equality of the tax burden to all members of the same class. Amidon v. Kane, 444 Pa. 38, 279 A.2d 53 (1971). In Amidon, the Court held that the Uniformity Clause was violated where taxpayers enjoying the same privilege of receiving, earning or otherwise acquiring the same amount of income as others were required to pay a larger dollar amount of taxes.
The Majority’s counter to Marshall’s constitutional claims is to rely upon Pennsylvania Personal Income Tax Bulletin 2005-02, Section 2.6 However, the Bulletin’s provisions contradict the Majority’s assertion that the loss occasioned by the dissolution of this limited Partnership must be sourced outside the Commonwealth for a nonresident limited partner because (a) the Bulletin only speaks of gains, not losses, and (b), the Bulletin applies only to going concerns. As to (a), the dissolution that occasioned the loss in this instance is not even mentioned in the Bulletin, so clearly the Bulletin does not provide a basis for the outsourcing of the subject loss. With respect to (b), the Partnership clearly was not a “going concern” at the time of dissolution. The Partnership’s only source of income and business activity was the property, which had been previously foreclosed upon. Hence, the *105Partnership was an idle and empty shell by the time it was dissolved.
Consequently, Marshall should be given the same benefit as resident limited partners and be permitted to offset his pro rata share of the dissolution loss against income. I also do not believe that it is necessary to remand this matter to the Board for this determination. Since this Court sits in review de novo, the parties should be directed to supplement the record so that the amount of loss attributed to Marshall may be identified and applied to his tax benefit.
For these reasons, I respectfully dissent from the Majority’s decision.
Judge SIMPSON joins in this dissenting opinion.

. The Majority Opinion which, as noted above, largely adopts the Commonwealth's argument that the foreclosure of the Property and resultant discharge of indebtedness constitutes a taxable sale or other disposition of property, nonetheless seeks to isolate and differentiate the "discharge of indebtedness” from the “Sale or other disposition” that triggered it. I believe this is incorrect, however, for the only "income” that the Majority Opinion attributes to Marshall is that which was derived from the discharge of indebtedness that the Commonwealth posits resulted from the subject foreclosure, i.e., the “sale or other disposition” of Property. I respectfully submit that, since there is no cash or other boot that was derived from the foreclosure that the Majority Opinion attributes to Marshall, its attribution is either predicated upon the incorrect notion (and the Commonwealth's argument) that the income realized from the sale or other disposition of the Property is the income derived from the discharge of indebtedness (which is not income under the PIT, see 1 Pa.C.S. §§ 1921(b)(3) and 1928(b)) or that there is no income at all. Moreover, the Majority Opinion buttresses the attribution of income to Marshall on the Tufts and Allan decisions, both of which dealt with the issue of whether there is income derived from a discharge of nonrecourse indebtedness resulting from a sale or other disposition of property. Neither case derived income from any source as a result of the sale or other disposition of property which was the subject of the respective cases. As will be disclosed infra, I believe the Majority Opinion’s reliance on Tufts and Allan is also misplaced.

. As Professor Boris I. Bittker so aptly stated:
Relief from a nonrecourse loan is not an economic benefit if it can be obtained only by giving up the mortgaged property. It is analogous to the relief one obtains from local real property taxes by disposing of the property. Like nonrecourse debt, the taxes must be paid to retain the property; but no one would suggest that the disposition of unprofitable property produces economic benefit equal to the present value of the taxes not paid in the future.
Bittker, "Tax Shelters, Nonrecourse Debt, and the Crane Case”, 33 Tax L.Rev. 277, 282 (1978).

. If the subject nonrecourse debt is not a “true loan,” it would be equity akin to preferred stock inasmuch as the holder would have a preference as to the disposition of the property, which is the case here. Consequently, the "interest" payments to the lender would be treated for tax purposes as nondeductible dividends that would not shelter the aforementioned $121.6 million of Partnership income.

.The application of the tax benefit rule to reflect the economic reality of a taxable event is a substance over form approach, which is supported by this Court's decision in Commonwealth v. Rigling, 48 Pa.Cmwlth. 303, 409 A.2d 936 (Pa.Cmwlth.1980), wherein we held that the basis provisions of the PIT could not be applied to impose a tax when there is in fact no income.

. As the Majority notes, Marshall had no other Pennsylvania sources of income or loss.

. A copy of this Bulletin is attached as Appendix A to the Commonwealth's brief.