On October 17, the Pennsylvania Supreme Court issued its decision in Allfirst Bank v. Commonwealth, upholding the Constitutionality of the Pennsylvania bank shares tax as applied to banks with non-Pennsylvania shareholders. The bank shares tax is an annual tax imposed by Pennsylvania based on the taxable value of shares issued by a bank. Banks doing business in Pennsylvania are subject to bank shares tax but are not subject to Pennsylvania corporation income and franchise tax.

Allfirst Bank challenged the Constitutionality of the bank shares tax, arguing that the tax, measured by the value of the bank’s shares, was a tax on the property of the bank’s out-of-state shareholder. Allfirst argued that because Allfirst’s shareholder was domiciled outside of Pennsylvania and had no other connection to Pennsylvania the application of the shares tax to Allfirst’s shares constituted a violation of the Constitution’s Due Process Clause. In supporting its argument that the tax was imposed on Allfirst’s shareholder, Allfirst relied on the language of the statute which gave the bank the right to pay the tax “either from its general fund, or from the amount of said tax collected from its shareholders….”, as well as decisions in cases arising under prior versions of the shares tax, which had interpreted the shares tax as a tax on a bank’s shareholders.

A majority court rejected Allfirst’s argument. In concluding that the tax was imposed on banks, and not on their shareholders, the court relied on the fact that Pennsylvania had no recourse against its shareholders in the event of nonpayment of tax and that the tax was required to be paid by the bank, not by the shareholders.

Although this decision is not good news for the many banks that had pending refund claims based on the Constitutional argument raised by Allfirst, this decision is not necessarily unwelcome news for all banks. If Allfirst had prevailed, this would have no effect on the imposition of the shares tax on banks with Pennsylvania domiciled shareholders. In addition, as noted above, banks subject to the shares tax are not subject to Pennsylvania corporate net income tax and franchise tax for years beginning after December 31, 2000. Thus, if Allfirst had prevailed, banks with non-Pennsylvania shareholders could have faced liability for corporate net income tax and franchise tax for all years beginning after December 31, 2000. For many banks, the potential liability for Pennsylvania corporate taxes would have exceeded any bank shares tax savings that would have resulted from an Allfirst victory.

Though the shares tax has overcome the Allfirst attack, it remains a target. Several other Constitutional challenges have been raised by other taxpayers.

For example, in the Lebanon Valley Farmers Bank case, which is currently pending before the Commonwealth Court, the taxpayer argues that the method of computing the shares tax base violates the Uniformity Clause of the Pennsylvania Constitution. The taxpayer contends that the tax treats mergers of two in-state banks differently than mergers of in-state banks with out-of-state banks.. This position results from the holding in First Union National Bank v. Commonwealth, 885 A.2d 112 (Pa. Commw. 2005) (later affirmed by the Pennsylvania Supreme Court) which determined that, according to the statute, a bank that survives a merger with an out-ofstate bank may exclude the value of that out-of-state bank from the shares tax base.

Another Constitutional issue that has been raised with respect to the bank shares tax is whether the inclusion of historical values in the shares tax base results in the taxation of non-unitary values by Pennsylvania in violation of the Commerce Clause requirement of fair apportionment. For instance, in First Union, the taxpayer argued that when a bank acquires and merges with a bank and both banks are “institutions” at the time of the merger, the values of the two banks cannot be combined for shares tax purposes unless both banks were unitary throughout the 6-year measurement period used to determine the shares tax base. The Commonwealth Court never needed to reach this argument to resolve the First Union case, but it nonetheless reacted favorably to the argument in a footnote included in the decision. We expect that banks that are the result of mergers of two or more “institutions” (and which are not covered by the decision in First Union) may raise this argument again in future appeals.

In PNC Bank, another case pending before the Commonwealth Court, the taxpayer has raised a different issue – whether the inclusion of Federal Home Loan Bank stock in the shares tax base constitutes a violation of the Constitutional immunity from state taxation enjoyed by federal obligations.

Therefore, the Allfirst decision is not the end of the story. With several constitutional issues still unresolved, we expect the bank shares tax to continue to be the focus of controversy for the foreseeable future.