Avoiding ‘Deja Vu 2’ In High Court CSX Tax Case

Avoiding ‘Deja Vu 2’ In High Court CSX Tax Case

The following post was originally published by Law360 on December 18, 2014.

The oral arguments before the U.S. Supreme Court last week in Alabama Department of Revenue v. CSX Transportation Inc. found the justices seeking a manageable way to evaluate whether a state tax statute is discriminatory while also keeping the case from appearing before the court for a third time.

At issue is a provision of the Railroad Revitalization and Regulatory Reform Act of 1976 (4-R Act) that prohibits a state from discriminating against a railroad in its tax regime. How the Supreme Court approaches its analysis will impact not only similar railroad appeals pending across the county, but also a variety of other taxpayers protected from discriminatory taxation by congressional action.

Section 306 of the 4-R Act, codified at 49 U.S.C. 11501, broadly prohibits states from engaging in four discrete types of tax discrimination against railroads. While the first three involve discriminatory property taxes, subsection (b)(4) prohibits a state from “impos[ing] another tax that discriminates against a rail carrier.”

Alabama imposes a general sales and use tax that applies to the purchase or use of diesel fuel in the state, based on the fuel’s sale price. Railroads pay the tax when they purchase diesel fuel, but Alabama provides an exemption for motor carriers and water carriers. Instead, motor carriers pay a per-gallon excise tax on their purchases of diesel fuel, a tax that railroads do not pay. Water carriers are not subject to the per-gallon excise tax.

In 2008, CSX sued the state, claiming that the sales and use tax on diesel fuel — and the exemption for the railroads’ competitors in particular — discriminated against the railroads in violation of the 4-R Act. On its first trip to the Supreme Court in 2011, CSX argued that subsection (b)(4) could be used to challenge a sales tax exemption. In a 7-2 decision, the Supreme Court agreed with CSX, but remanded the case for a determination of whether discrimination actually existed under Alabama’s tax regime. Justices Clarence Thomas and Ruth Bader Ginsburg dissented from that opinion on the grounds that a tax exemption is only discriminatory if it singles out railroads by comparison to other commercial and industrial taxpayers — the standard applicable under subsections (b)(1) to (b)(3).

On remand, the parties stipulated that the railroads’ primary competitors are motor carriers and water carriers. Based on that stipulated comparison class, the district court — in one paragraph — found that Alabama’s tax regime on fuel was not discriminatory because, during the tax years at issue, the railroads and motor carriers paid similar taxes per gallon of fuel. The court also found that CSX had failed to prove a discriminatory effect with regard to the exemption for water carriers.

The Eleventh Circuit reversed, holding that subsection (b)(4) calls only for an examination of the challenged tax, rather than the “Sisyphean burden” of evaluating the fairness of a state’s entire tax regime. Because the railroads pay the sales tax on their fuel purchases and their competitors do not, the court found that Alabama’s tax violated the 4-R Act.

In its petition for certiorari, Alabama framed the issue narrowly as whether a state discriminates against a railroad in violation of the 4-R Act when it imposes a generally applicable sales tax, but grants exemptions for the railroads’ competitors. On that question, the justices seemed to agree with CSX and Elaine Goldenberg, the assistant to the U.S. Solicitor General, who in representing the U.S. filed an amicus brief in support of neither party.

Andrew Brasher, the solicitor general of Alabama, spent the first half of his argument trying to convince the Supreme Court that the appropriate comparison class for a 4-R Act inquiry should be “the mass of other businesses in the state” with a focus on whether the state is targeting railroads with a tax that other businesses do not have to pay. Justice Antonin Scalia immediately pointed out that Congress could have included language expanding subsection (b)(4) to a class of all commercial and industrial taxpayers, as it did for the earlier subsections. Justice Elena Kagan emphasized that Alabama’s proposed comparison class “flies straight into the face of” CSX I.

Alabama similarly found little support from Chief Justice John Roberts, who questioned why Congress would grant the railroads broad protections under the 4-R Act but still want to expose them to unfair competition by states that choose to give tax benefits to the railroads’ competitors. Indeed, the intent of the 4-R Act was to ensure the economic viability of the railroads, and their economic viability depends on how they fare against their competitors, not how they fare against, for example, an agricultural conglomerate in the state.

Brasher argued that many businesses pay sales tax on diesel fuel, like the railroads, but in her turn at the podium Goldenberg disagreed, noting that many commercial or industrial taxpayers use little to no diesel fuel. If the vast majority of diesel fuel is purchased by the railroads and their competitors, then the most reasonable comparison would be the railroads and their competitors. And despite the state’s arguments to the contrary, Goldenberg did not believe that the railroads would be likely to sue if noncompetitors were tax advantaged, because the railroads’ financial stability would not be implicated.

If the only issue to be resolved was the competitor class rule, it might have been a short morning before the Supreme Court, and a circuit split on that issue may have been quickly resolved. Instead, the court waded into murkier waters by asking the parties to brief and argue a second issue not raised by Alabama, namely whether a court, in resolving a 4-R Act discrimination claim, should consider other aspects of the state’s tax regime. In short, was the Eleventh Circuit correct in examining only Alabama’s sales and use tax, or was the district court correct in examining Alabama’s entire tax regime?

The answer, according to the parties, depends on which is easiest to administer, but the parties could not agree on whether each court’s analyses were too “simpleminded” or whether the opposite party’s proposed test would be too complicated.

According to Brasher, the analysis need not be complicated; the district court was able to do it in one paragraph. Alabama’s proposed rule would have courts simply compare the taxes imposed on diesel fuel for motor carriers with the taxes paid by railroads on the same item. In this case, the district court found that the taxes were comparable and that the railroads suffered no harm.

Representing CSX, Carter Phillips argued that the district court’s analysis was overly simplistic. Citing Professor Walter Hellerstein’s influential article on complementary taxes, Phillips noted that the taxes at issue in this case are not “mutually exclusive proxies” for one another. They are imposed on different activities at different rates and for different purposes. Accordingly, the district court erred in simply comparing the two taxes and finding them “close enough.” And as Justice Sonia Sotomayor emphasized, even the district court found “fortuitous” the fact that the two taxes were roughly equal during the years in question; such equality could change depending on the retail price of diesel fuel.

On the other hand, the justices did not seem persuaded that the Eleventh Circuit’s analysis was sufficient either. Justices Stephen Breyer and Kagan questioned why the Eleventh Circuit chose not to conduct a comparability analysis of any sort. Phillips explained that where taxes are not mutually exclusive proxies, the court will not be able to develop a set of standards of comparability, but Justice Breyer seemed unconvinced. How can a judge determine whether a tax is discriminating against railroads, he asked, without knowing how the money will be spent by the state?

Justice Breyer predicted that even if motor carriers were taxed more heavily than railroads, the railroads could still argue for discrimination on the grounds that, for example, the extra taxes supported highways from which the railroads received no benefit. Phillips countered that the railroads could not support such a claim, but that those were not the facts presented here.

Justice Sotomayor also was not moved by CSX’s position that how a state spends its tax dollars would be relevant to a discrimination claim under the 4-R Act. Phillips responded that when a state creates a discriminatory tax, the state has the burden of justifying it. Thus, it would not be the railroads’ burden to show that the tax dollars are being spent fairly.

On the second issue, Goldenberg agreed with Alabama and focused her discussion on the tests developed under the dormant Commerce Clause. However, as CSX and some of the amici correctly pointed out, the dormant Commerce Clause is not implicated where Congress has affirmatively used its Commerce Clause powers. In order to fully accept Goldenberg’s analysis of the second issue, the court would have to find that dormant Commerce Clause jurisprudence applies to scenarios where Congress has spoken.

The final complicating factor raised by the parties was Alabama’s exemption for water carriers. While the district court and Eleventh Circuit focused almost exclusively on the taxes paid or not paid by the railroads and their motor carrier competitors, the parties had stipulated that water carriers were also the railroads’ competitors. Unlike motor carriers, water carriers do not pay another tax on diesel fuel, at least in some circumstances.

Brasher argued that CSX did not prove that the railroads suffered a real disadvantage as a result of the exemption for water carriers, a position accepted by the district court. To Phillips, however, CSX had no burden to provide such evidence, as Alabama stipulated the argument away. Goldenberg was similarly “dubious” of the district court’s reasons why the water carrier exemption is not discriminatory, but she suggested that the water carrier issue be remanded to the Eleventh Circuit because it did not address the district court’s holding on that issue. The justices seemed skeptical, at best, that remanding to the circuit court would end this case without another cert petition.

So how will the Supreme Court find its way out of this maze of its own making? Perhaps the easiest way for the court to resolve this case would be to limit its decision to the single issue raised by Alabama in its cert petition. Most of the justices seemed to agree with CSX and the solicitor general that the appropriate comparison class under the 4-R Act is the railroads’ competitors. Because water carriers are exempted from the sales tax on diesel fuel and do not pay a tax — complementary or otherwise — on their diesel fuel purchases, the court could definitively end this case on the basis of the first issue.

The Supreme Court added the second issue sua sponte, despite the solicitor general’s opinion that this case would not be an appropriate vehicle for clarifying the discrimination inquiry. Now having seen how messy the discrimination issue is, the court may realize that the best path forward is to issue a narrow decision ending this particular case and let the second issue come to the court on its own, if and when it is properly raised and briefed by future parties — and where the record might allow the court to cleanly make a determination.

Such a decision would also promote consistency for taxpayers more broadly. By making a clear pronouncement that the railroads’ competitors are the appropriate comparison class in a 4-R Act discrimination analysis, the court would keep its 4-R Act jurisprudence in line with the methodology applied to other statutory discrimination claims under federal statutes protecting other industries, including the Electricity Act, Motor Carriers Act and Internet Tax Freedom Act, among others.

Only time will tell which issue or issues the Supreme Court will address. One thing, however, is certain: the high court does not want its decision in CSX II to lead to a CSX III.

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