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The West Virginia Supreme Court of Appeals found in the CSX case that allowing a credit for state, but not local, sales taxes paid in other states violates the dormant Commerce Clause. In this article, West Virginia University College of Law Professor Elaine Waterhouse Wilson, and Adjunct Professor Robert G. Tweel, discuss the case and its implications.
By Elaine Waterhouse Wilson and Robert G. Tweel
Elaine Waterhouse Wilson is a Professor of Law at the West Virginia University College of Law, Morgantown, West Virginia. Robert G. Tweel is a member of Jackson Kelly, PLLC, Charleston, West Virginia. Robert is also an adjunct professor at the West Virginia University of College of Law, where he teaches state and local taxation.
In late 2016, the West Virginia Supreme Court of Appeals in Matkovich v. CSX Transportation, 793 S.E.2d 888 (W. Va. 2016), held that the dormant commerce clause of the U.S. Constitution requires West Virginia to credit taxes paid to municipalities of other states against the West Virginia use tax on motor fuel. In so holding, the West Virginia Supreme Court extended the doctrine enunciated in Comptroller of the Treasury v. Wynne, 135 S. Ct. 1787 (2015), which required Maryland to credit income taxes paid to the municipalities to other states against Maryland's income tax. The U.S. Supreme Court denied West Virginia's petition for certiorari ( Matkovich, 793 S.E.2d at 888, cert. denied Steager v. CSX Transp., Inc., No. 16-1251, 2017 U.S. LEXIS 5204 (2017)), (Che Odom, High Court Bypasses CSX Out-of-State Tax Credit Case, Daily Tax Report: State (Oct. 3, 2017), http://src.bna.com/s3R), leaving CSX Transportation to stand as the latest pronouncement in this continuing state tax legal saga.
CSX Transportation is an interstate railroad operator, which is incorporated in Virginia with headquarters in Florida, that operates railways that move through and stop in West Virginia. It is one of the primary East Coast carriers of coal, a significant industry in West Virginia. The decline in the West Virginia coal industry has put economic pressure on those businesses that service the mines, including railroads. Michael Virtanen, Coal Trains Fewer as Appalachian Railroads Keep Rolling, U.S. News (May 28, 2017, 10:47 AM), https://www.usnews.com/news/best-states/west-virginia/articles/2017-05-28/coal-trains-fewer-as-appalachian-railroads-keep-rolling. The reduction of revenue from coal and related industries has, in turn, precipitated a significant budget crisis in West Virginia. Ted Boettner, Tackling West Virginia's Budget Crisis, West Virginia Center on Budget & Policy Blog (Jan. 18, 2017, 9:39 AM), http://www.wvpolicy.org/tackling-west-virginias-budget-crisis/. Thus, West Virginia is in the sometimes contradictory position of wanting to support its primary extractive industry while also strictly protecting its state tax base.
Like many states, West Virginia imposes a motor fuel use tax on fuel used in the state that is not purchased in the state (and therefore, not subject to West Virginia sales tax). The use tax calculation is based upon the percentage of miles traveled in West Virginia in relation to the total miles traveled. West Virginia does allow a credit for motor fuel sales taxes paid to other states, but does not allow for a credit against motor fuel sales taxes paid to municipalities in other states. W. Va. Code §§II-I5A-lOa and ll-I5A-13 (2016). The West Virginia credit statute at issue in Matkovich v. CSX Transportation provides a credit against all West Virginia use taxes, not just the motor fuel excise tax. See W. Va. Code §11-15A-10a (2016). For the motor fuel excise tax, West Virginia prohibits its counties and municipalities from imposing motor fuel use and sales taxes. See W. Va. Code §§7-22-12(b), 8-13C-4(c)(1)(B), 8-38-12(b) and 11-15-9f (2016).
CSX Transportation: The Lower Courts
The West Virginia Tax Department field audited CSX in 2010, during which it determined that CSX was using motor fuel purchased outside of West Virginia in its operations within the state. Matkovich, 793 S.E.2d at 891. As such, CSX was subject to West Virginia's use tax on fuel. Id. In response, CSX re-calculated its West Virginia use tax by taking a credit for sales taxes paid to other states and to municipalities of other states. Id. While West Virginia allowed the credit with regard to fuel sales taxes paid to other states, West Virginia disallowed the credit for sales taxes paid to out-of-state municipalities. Id. at 891–92.
On administrative appeal, the West Virginia Office of Tax Appeals found that the denial of credit for use tax paid to out-of-state municipalities violated the dormant Commerce Clause of the U.S. Constitution. Id. at 892. The Circuit Court of Kanawha County, West Virginia affirmed the ruling of the Office of Tax Appeals, ( CSX Transp., Inc. v. Matkovich, No. 15-0935, CA No. 15-AA-36, http://www.courtswv.gov/supreme-court/calendar/2016/briefs/oct16/15-0935order.pdf) which was then appealed to the West Virginia Supreme Court of Appeals. (West Virginia does not have an intermediate level court of appeals; thus, the Circuit Court's opinion was appealable directly to the West Virginia Supreme Court).
Wynne: Inherently Discriminatory or Just Good Planning?
The Commerce Clause of the U.S. Constitution provides that Congress has the power to “regulate Commerce with foreign Nations, and among the several States.” U.S. Const. art 1, §8. The Commerce Clause clearly gives Congress the affirmative power to regulate commerce; as a corollary, the states cannot interfere with Congress' authority over interstate commerce. Under the “dormant” Commerce Clause doctrine, a state tax regulation will not interfere with interstate commerce if (1) it has a substantial nexus with the state, (2) it is fairly apportioned; (3) it does not discriminate, and (4) it is fairly related to the services provided by the State. Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1977). The West Virginia Supreme Court found that three of the four factors of the Complete Auto test had been met: nexus, non-discrimination, and relatedness; West Virginia's use tax did not, however, meet the fair apportionment test. Matkovich, 793 S.E.2d at 897–98. This case may have been decided under the discrimination test as opposed to a fair apportionment test, but the West Virginia Supreme Court determined that the Wynne precedent dictated the result of fair apportionment under the internal consistency test.
The fair apportionment test requires a state to tax only a “fair proportion of the taxpayer's business done within the state… .” Complete Auto Transit, Inc., 430 U.S. at 284 (quoting Spector Motor Serv. v. O'Connor, 340 U.S. 602, 610 (1951)). Fair apportionment requires the tax to be both internally consistent and externally consistent. Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159 (1983).
The internal consistency test “looks to the structure of the tax at issue to see whether its identical application by every State in the Union would place interstate commerce at a disadvantage as compared with commerce intrastate.” Wynne, 135 S. Ct. at 1802 ( citing Okla. Tax Comm'n v. Jefferson Lines, 514 U.S. 175, 185 (1995)). Wynne's hypothetical taxing scheme is designed to allow “courts to distinguish between (1) tax schemes that inherently discriminate against interstate commerce without regard to the tax policies of other States, and (2) tax schemes that create disparate incentives to engage in interstate commerce (and sometimes result in double taxation) only as a result of the interaction of two different but nondiscriminatory and internally consistent schemes.” Id. at 1803. The Wynne opinion notes that only those taxes that inherently discriminate are “typically unconstitutional” while those tax schemes that only create disparate incentives are usually not unconstitutional. Id.
Of course, the difficulty is determining whether a taxing scheme is unfairly apportioned because it is inherently discriminatory, or if it just provides planning opportunities for savvy tax lawyers.
In Wynne, Maryland's income tax did not allow a credit to Maryland residents for local taxes paid in other states. Id. at 1793. As a result, the out-of-state income of a Maryland resident would be subject to taxation both by Maryland and by the local taxing authority in the source state, making Maryland's denial of a credit for local taxes internally inconsistent. Id. at 1803–04. Justice Alito reached this result by concluding that “it is immaterial that Maryland assigns different labels (i.e., ’county tax’ and ’special nonresident tax’) to these taxes. In applying the dormant Commerce Clause, they must be considered as one.” Id. at 1803 n.8. Because all locally imposed taxes were defined as state taxes, the Court reasoned that failing to permit a credit for local taxes paid to other states placed a burden on interstate commerce because it would cause a taxpayer to not engage interstate commerce, favoring intrastate-sourced income that was only subject to tax once. Id. at 1792.
In CSX Transportation, the West Virginia State Tax Commissioner argued that local taxes should not be considered in evaluating its tax under the internal consistency argument because West Virginia prohibits municipalities and counties from imposing motor fuel sales and use taxes. See W. Va. Code §§7-22-12(b), 8-13C-4(c)(1)(B), 8-38-12(b) and 11-15-9f (2016). Thus, West Virginia argued, the hypothetical taxing scheme that would be in place in all other states for purposes of applying the internal consistency test would include the prohibition on municipal use taxes. This argument did not survive the conclusion in Wynne that the definition of state taxes must also include local taxes; thus West Virginia's prohibition on local use taxation was not relevant to the question of internal consistency. See generally Wynne, 135 S. Ct. 1787. Accordingly, the Supreme Court of Appeals of West Virginia held the tax violated the internal consistency requirement because it failed to permit a credit against the use tax for out of state local use taxes. Matkovich, 793 S.E.2d at 898.
Curiously, the argument of the West Virginia State Tax Commissioner is sound if you do not have to credit local taxes as being part of the state tax that must be credited. It would appear the better argument would have been that the tax discriminated against interstate commercial activity by subjecting CSX to a higher rate of tax than a purely intrastate operation; however, the holding in Wynne as applied in CSX Transportation clearly supports the conclusion that the use tax credit structure fails to satisfy the internal consistency test for fair apportionment.
By denying certiorari in CSX Transportation, the Supreme Court appears to support the West Virginia Supreme Court's expansive reading of Wynne, which at its outer limit would require any out-of-state local tax to be treated as part of the sales tax imposed by that state for internal consistency test purposes. Taken to its logical extreme, any state tax must have a credit for both state and local taxes paid to other jurisdictions in order to survive the fair apportionment prong of the Complete Auto test as interpreted by Wynne. One can anticipate that taxpayers will be aggressive in both refund suits and future tax filings on the issue of credits against state taxes of all types for out-of-state municipal taxes paid.
States, such as West Virginia, are faced with unappealing choices after CSX Transportation. West Virginia can continue essentially to subsidize out-of-state municipalities by continuing to prohibit West Virginia municipalities from charging use tax – at no point is another state crediting a taxpayer for West Virginia municipality taxes paid because there are no such things under West Virginia state law. In a time of a significant state budget crisis, West Virginia is hardly in a position to give up such revenue. To the extent that it does not already do so, West Virginia could increase the rate of its use tax on the state level, which would theoretically replicate the municipal taxes that West Virginia localities could have charged but for the prohibition of state law. Alternatively, West Virginia could lift the ban on municipalities imposing a use tax. In either case, a business paying West Virginia additional sales tax (either due to an increased state tax rate or due to additional municipal taxes) would receive a credit against for those taxes paid in other states. For a state that is trying to improve its business climate by keeping its state tax burdens low; neither of these options is particularly palatable. It may be that the option of simply increasing the state tax rate may be more acceptable than allowing municipalities to impose use taxes, as it is at least administratively simpler for businesses to deal with one taxing jurisdiction rather than many. In either event, CSX Transportation complicates an already difficult legal climate for state taxing authorities while giving businesses with multi-state operations the upper hand.
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