Taxation

Can a State impose a tax upon distribution of merchandise catalogues? Can a state impose a franchise fee upon door to door sales people? Can a state impose an income tax upon out of state corporations? What about a gross receipts tax? These some of the questions posed under this section. What if two states seek to impose income taxes on the same income of the same corporation? Are there any limits to the combined effect of multiple state taxation? The war between the commerce clause and local sales taxation has tremendous implications for the structure of commerce: for if non-local sellers have a competitive advantage over local sellers, as a result of differential taxation, then the structure of the local community is changed. Local merchandisers have a stake in their community; they participate in local organizations, target their donations to local charity, support local artistic organizations, and so on. At times it has seemed as though the dormant commerce clause has served in this area to foster discrimination against local business, rather than to promote equality.

Evolution of Jurisprudence: This is a topic far too complex to handle in a single panel. We could trace, for example, the evolution of decisions dealing with application of state income tax to non-resident corporations. Our purpose here, however, is to provide a flavor of the issues involved. Supreme Court jurisprudence in this area has been in a state of flux over the past several decades. The Court has struggled to find bright-line principled rules upon which parties could rely. At the same time, it has sought to shift the foundation of jurisprudence to a different footing. The history of the Supreme Court's treatment of local taxation of interstate commerce has been recited in the 1992 Quill case as follows:

• Our interpretation of the "negative" or "dormant" Commerce Clause has evolved substantially over the years, particularly as that clause concerns limitations on state taxation powers. See generally P. Hartman, Federal Limitations on State and Local Taxation 2:9-2:17 (1981). Our early cases, beginning with Brown v. Maryland, 12 Wheat. 419 (1827), swept broadly, and in Leloup v. Port of Mobile, 127 U.S. 640, 648 (1888), we declared that "no State has the right to lay a tax on interstate commerce in any form." We later narrowed that rule and distinguished between direct burdens on interstate commerce, which were prohibited, and indirect burdens, which generally were not. See, e.g., Sanford v. Poe, 69 F. 546 (CA6 1895), aff'd sub nom. Adams Express Co. v. Ohio State Auditor, 165 U.S. 194, 220 (1897). Western Live Stock v. Bureau of Revenue, 303 U.S. 250, 256 -258 (1938), and subsequent decisions rejected this formal, categorical analysis and adopted a "multiple-taxation doctrine" that focused not on whether a tax was "direct" or "indirect," but rather on whether a tax subjected interstate commerce to a risk of multiple taxation. However, in Freeman v. Hewit, 329 U.S. 249, 256 (1946), we embraced again the formal distinction between direct and indirect taxation, invalidating Indiana's imposition of a gross receipts tax on a particular transaction because that application would "impose[e] a direct tax on interstate sales." Most recently, in Complete Auto Transit, Inc. v. Brady, 430 U.S. 285 , we renounced the Freeman approach as "attaching constitutional significance to a semantic difference." We expressly overruled one of Freeman's progeny, Spector Motor Service, Inc. v. O'Connor, 340 U.S. 602 (1951), which held that a tax on "the privilege of doing interstate business" was unconstitutional, while recognizing that a differently denominated tax with the same economic effect would not be unconstitutional. Spector, as we observed in Railway Express Agency, Inc. v. Virginia, 358 U.S. 434, 441 (1959), created a situation in which "magic words or labels" could "disable an otherwise constitutional levy." Complete Auto emphasized the importance of looking past "the formal language of the tax statute [to] its practical effect," 430 U.S., at 279 , and set forth a four-part test that continues to govern the validity of state taxes under the Commerce Clause.

The modern approach evolved in COMPLETE AUTO TRANSIT, INC. v. BRADY, CHAIRMAN, MISSISSIPPI TAX COMMISSION (1977). Mississippi imposed a tax upon the privilege of doing business within its borders and imposed that tax upon a company engaged in the transportation of automobiles from Michigan to Mississippi. Until Complete Auto Transit, the Court had routinely rejected "privilege" taxes imposed upon companies engaged entirely in interstate transport. Under these decisions the court had imposed:

• a blanket prohibition against any state taxation imposed directly on an interstate transaction. [The Court] explicitly deemed unnecessary to the decision of the case any showing of discrimination against interstate commerce or error in apportionment of the tax. [It] recognized that a State could constitutionally tax local manufacture, impose license taxes on corporations doing business in the State, tax property within the State, and tax the privilege of residence in the State and measure the privilege by net income, including that derived from interstate commerce. Nevertheless, a direct tax on interstate sales, even if fairly apportioned and nondiscriminatory, was held to be unconstitutional per se.

The Court regarded this approach as unsound. It was time to look, not at the name given to the tax, but rather to its purpose and effect. Instead of looking at the formal name of the tax, the Court would now follow a four part test. The Four Part "Complete Auto Test" now applied by the Supreme Court states that a tax will be sustained against a Commerce Clause challenge so long as the tax is:

1. Applied to an activity with a substantial nexus with the taxing State,
2. is fairly apportioned,
3. Does not discriminate against interstate commerce, and
4. Is fairly related to the services provided by the State. 430 U.S., at 279 .

Discrimination Means Unequal Treatment of Similarly Situated Entities: GENERAL MOTORS CORP. v. TRACY (1997) The State of Ohio imposed its general sales and use taxes on natural gas purchases from all sellers, whether in state or out of state, except regulated public utilities that meet Ohio's statutory definition of a "natural gas company." Under Ohio law, a regulated public utility natural gas company qualified for the exemption when engaged in the business of supplying natural gas for lighting, power, or heating purposes to consumers within this state. It is undisputed that natural gas utilities (generally termed "local distribution companies" or LDCs) located in Ohio satisfy this definition of "natural gas company." The statutory definition excluded out of state natural gas suppliers. In the past, non-local distribution companies generally did not exist. But changes in federal regulatory legislation engendered a new class of non-local companies serving large customers, such as General Motors.

The Court's decision traces the development of the natural gas industry. Local government began to provide public utility status to local gas distribution companies. Municipalities recognized that it was not practical to allow competing natural gas companies to locate service lines in public streets. Consolidation in the industry also engendered public utility price regulation to avoid price gouging. The Supreme Court responded to challenges to local regulation by affirming the States' power to regulate, as a matter of local concern, all direct sales of gas to consumers within their borders, absent congressional prohibition of such state regulation. See, e.g., Pennsylvania Gas Co. v. Public Serv. Comm'n of N. Y., 252 U.S. 23, 28-31 (1920); Public Util. Comm'n of Kan. v. Landon, 249 U.S. 236, 245-246 (1919). At the same time, the Court concluded that the dormant Commerce Clause prevents the States from regulating interstate transportation or sales for resale of natural gas. See, e.g., Missouri ex rel. Barrett v. Kansas National Gas Co., 265 U.S. 298, 307-310 (1924); Pennsylvania v. West Virginia, 262 U.S. 553, 596-600, reaffirmed on rehearing, 263 U.S. 350 (1923). See generally Illinois Natural Gas Co. v. Central Ill. Public Service Co., 314 U.S. 498, 504 -505 (1942) Then, as Congress began to regulate natural gas, it too relegated regulation of the intrastate market.

This history raised in the Court's mind the crucial question: were the taxed and non-taxed companies similarly situated:

• Conceptually, of course, any notion of discrimination assumes a comparison of substantially similar entities. Although this central assumption has more often than not itself remained dormant in this Court's opinions on state discrimination subject to review under the dormant Commerce Clause, when the allegedly competing entities provide different products, as here, there is a threshold question whether the companies are indeed similarly situated for constitutional purposes. This is so for the simple reason that the difference in products may mean that the different entities serve different markets, and would continue to do so even if the supposedly discriminatory burden were removed. If in fact that should be the case, eliminating the tax or other regulatory differential would not serve the dormant Commerce Clause's fundamental objective of preserving a national market for competition undisturbed by preferential advantages conferred by a State upon its residents or resident competitors.

The Tracy decision contains an element of deference to local regulators: it recognizes that courts are at times ill equipped to weigh the economic considerations involved in upsetting a highly regulated local market. "The Court is institutionally unsuited to gather the facts upon which economic predictions can be made, and professionally untrained to make them....We are consequently ill qualified to develop Commerce Clause doctrine dependent on any such predictive judgments, and it behooves us to be as reticent about projecting the effect of applying the Commerce Clause here, as we customarily are in declining to engage in elaborate analysis of real world economic effects.......Prudence thus counsels against running the risk of weakening or destroying a regulatory scheme of public service and protection recognized by Congress despite its noncompetitive, monopolistic character. Still less is that risk justifiable in light of Congress's own power and institutional competence to decide upon and effectuate any desirable changes in the scheme that has evolved. Congress has the capacity to investigate and analyze facts beyond anything the judiciary could match, joined with the authority of the commerce power to run economic risks that the judiciary should confront only when the constitutional or statutory mandate for judicial choice is clear."

The negative or dormant implication of the Commerce Clause prohibits state taxation, see, e.g., Quill Corp. v. North Dakota, 504 U.S. 298, 312 -313 (1992), or regulation, see, e.g., Brown Forman Distillers Corp. v. New York State Liquor Authority, 476 U.S. 573, 578 -579 (1986), that discriminates against or unduly burdens interstate commerce and thereby "imped[es] free private trade in the national marketplace,"

Mail-Order Companies: In NATIONAL BELLAS HESS, INC. v. DEPARTMENT OF REVENUE 386 U.S. 753 (1967) the Court used a relatively short opinion to strike down a State's application of sales or use taxes to an out of state mail order operation with no local facilities. The majority had no difficulty whatsoever in concluding that such a tax would violate the commerce clause:

• And if the power of Illinois to impose use tax burdens upon National were upheld, the resulting impediments upon the free conduct of its interstate business would be neither imaginary nor remote. For if Illinois can impose such burdens, so can every other State, and so, indeed, can every municipality, every school district, and every other political subdivision throughout the Nation with power to impose sales and use taxes. 12 The many variations in rates of tax,13 in allowable exemptions, and in administrative and record-keeping requirements could entangle National's inter-state business in a virtual welter of complicated obligations to local jurisdictions with no legitimate claim to impose 'a fair share of the cost of the local government.

Why is it harder for a multi-million dollar national enterprise to calculate local sales taxes than for a small struggling mom-and-pop store? What is the factual foundation upon which the Court's conclusion here? Would this problem lose its significance if low-cost sales tax calculation programs were readily available?

Dissenting Justices argued that this result did not destroy discrimination, but actually promoted and favored discrimination in favor of out-of-state enterprises:

• Bellas Hess enjoys the benefits of, and profits from the facilities nurtured by, the State of Illinois as fully as if it were a retail store or maintained salesmen therein. Indeed, if it did either, he benefit that it received from the State of Illinois would be no more than it now has- the ability to make sales of its merchandise, to utilize credit facilities, and to realize a profit; and, at the same time, it would be required to pay additional taxes. Under the present arrangement, it conducts its substantial, regular, and systematic business in Illinois and the State demands only that it collect from its customer-users-and remit to the State-the use tax which is merely equal to the sales tax which resident merchants must collect and remit. To excuse Bellas Hess from this obligation is to burden and penalize retailers located in Illinois who must collect the sales tax from their customers. In Illinois the rate is 3 1/2%, and when it is realized that in some communities the sales tax requires, in effect, that as much as 5% be added to the amount that customers of local, tax- paying stores must pay,3 the importance of the competitive discrimination becomes apparent. While this advantage to out-of-state sellers is tolerable and a necessary constitutional consequence where the sales are occasional, minor and sporadic and not the result of a calculated, systematic exploitation of the market, it certainly should not be extended to instances where the out-of-state company is engaged in exploiting the local market on a regular, systematic, large-scale basis. In such cases, the difference between the nature of the business conducted by the mail order house and by the local enterprise is not entitled to constitutional significance. The national mail order business amounts to over $2,400,000, 000 a year. Some of this is undoubtedly subject to the full range of taxes because of the location of stores in the various States,5 and some of it is and should be exempt from state use tax because of its sporadic or minor nature. See Report of the Special Subcommittee on State Taxation of Interstate Commerce of the House Judiciary Committee, H.R.Rep. No. 565, 89th Cong., 1st Sess., Vol. 3 (1965), at 770-777. But the volume which, under the present decision, will be placed in a favored position and exempted from bearing its fair burden of the collection of state taxes certainly will be substantial, and as state sales taxes increase, this haven of immunity may well increase in size and importance. It is hardly worth remarking that appellant's expressions of consternation and alarm at the burden which the mechanics of compliance with use tax obligations would place upon it and others similarly situated should not give us pause. The burden is no greater than that placed upon local retailers by comparable sales tax obligations; and the Court's response that these administrative and record keeping requirements could 'entangle' appellant's interstate business in a welter of complicated obligations vastly underestimates the skill of contemporary man and his machines.

Bellas not quite overturned: By 1992, the Court came to the brink of over-turning its prohibition on local taxation of mail order companies, but drew back at the thought of taking away the economic advantage historically conferred on these companies. QUILL CORP. v. HEITKAMP, 504 U.S. 298 (1992) Quill was a Delaware corporation with offices and warehouses in Illinois, California, and Georgia. Its sole connection with the State of North Dakota, however, was that it had customers in that State. None of its employees worked or resided in North Dakota, and its ownership of tangible property in that State was either insignificant or nonexistent. Quill sold office equipment and supplies; it solicited business through catalogs and flyers, advertisements in national periodicals, and telephone calls. Its annual national sales exceeded $200 million, of which almost $1 million was made to about 3,000 customers in North Dakota. Quill was the sixth largest vendor of office supplies in the North Dakota. It delivers all of its merchandise to its North Dakota customers by mail or common carrier from out-of-state locations. North Dakota attempted to apply a tax on sales made within the state by companies which solicited business within the state.

Until the Quill decision, the Court had founded its rejection of local taxation on both commerce clause and due process clause limitations on taxation of out-of-state enterprises. The due process clause requires some connection between the enterprise sufficient to subject that enterprise to the taxing power of the state. The dormant commerce clause has a different function: to prevent local interference with the stream of commerce. But by 1992, the due process limitations had been all but removed. In Bellas the Court had written as if the two restrictions were virtually one and the same. In view of the changes in due process decisions, the Court was compelled to find that Quill had subjected itself to the taxing power by engaging " in continuous and widespread solicitation of business within the State." Consequently, the Court must either overturn Bellas or conclude that the due process restriction and the commerce restriction differed in this respect. The Court noted that a reversal of Bellas would have significant impact on the national mail order operations which had grown to rely on their favored positions. Should not Congress, rather that the Courts, make this ultimate decision? Hence Bellas was reaffirmed.

Compensatory Tax: A state may attempt to level the playing field between local and out of state commerce by levying a so-called compensatory tax. The Court will sustain such a tax if it is a truly compensatory tax' designed simply to make interstate commerce bear a burden already borne by intrastate commerce. In FULTON CORP. v. FAULKNER, (1996), North Carolina levied an "intangibles tax" on a fraction of the value of corporate stock owned by state residents inversely proportional to the corporation's exposure to the State's income tax. In order to qualify as a truly compensatory tax, the tax must pass a three part test. First, "a State must, as a threshold matter, `identif[y] . . . the [intrastate tax] burden for which the State is attempting to compensate. Second, "the tax on interstate commerce must be shown roughly to approximate - but not exceed - the amount of the tax on intrastate commerce." "Finally, the events on which the interstate and intrastate taxes are imposed must be `substantially equivalent; that is, they must be sufficiently similar in substance to serve as mutually exclusive `prox[ies]' for each other."

Burden for which the tax compensates: The State defended its tax as compensating for general services provided within the state and supported through the local system of taxation. But the Court will not allow states to impose taxes designed to make up for the general level of intrastate taxation:

• [North Carolina's] argument is unconvincing, and we rejected a counterpart of it in Oregon Waste, where we held that Oregon could not charge an increased fee for disposal of waste generated out of state on the theory that in-state waste generators supported the cost of waste disposal facilities through general income taxes. Although we relied primarily upon the conclusion that earning income and disposing of waste are not "substantially equivalent taxable events," we also spoke of the danger of treating general revenue measures as relevant intrastate burdens for purposes of the compensatory tax doctrine. "[P]ermitting discriminatory taxes on interstate commerce to compensate for charges purportedly included in general forms of intrastate taxation would allow a state to tax interstate commerce more heavily than in-state commerce anytime the entities involved in interstate commerce happened to use facilities supported by general state tax funds." Id., at (internal quotation marks and citation omitted). We declined then, as we do now, "to open such an expansive loophole in our carefully confined compensatory tax jurisprudence." Ibid.

Approximate Equivalence: The Court likewise found that the tax failed the approximate equivalence test. The North Carolina formula equalized the taxes of in-state and out of state taxpayers. But the equivalence test requires equalization of payments for services actually rendered to the out-of-state entity, not all taxes assessed within the State:

• When a corporation doing business in a State pays its general corporate income tax, it pays for a wide range of things: construction and maintenance of a transportation network, institutions that educate the workforce, local police and fire protection, and so on. The Secretary's justification for the intangibles tax, however, rests on only one of the many services funded by the corporate income tax, the maintenance of a capital market for the shares of both foreign and domestic corporations. To the extent that corporations do their business outside North Carolina, after all, they get little else from the State. Even, then, if we suppressed our suspicion that North Carolina actually funds its capital market through its Blue Sky fees, not its general corporate taxation, the relevant comparison for our analysis has to be between the size of the intangibles tax and that of the corporate income taxes component that purportedly funds the capital market.