County Lawyers Claim Success in Supreme Court Tax Ruling

The tax on corporate shares of out-of-state companies was imposed under a state law. Walter Annenberg and his wife challenged the state tax as unconstitutional, claiming it violated the Commerce Clause of the U.S. Constitution.



“The portion of the stock clause tax which the Annenbergs attacked as being unconstitutional … excludes from personal property tax stock held in entities to which the capital stock and franchise tax apply,” the court explained in a footnote. “The net effect of the stock clause is that the only stock on which an owner is liable to pay tax pursuant to the stock clause is on stock in foreign corporations which do not do business in Pennsylvania.”



In the Supreme Court’s first decision in this case, it ruled that the stock clause of the personal-property tax facially discriminated against interstate commerce.



“However we did not declare that the stock clause was unconstitutional at that point,” the court said. “Rather, we noted that a tax provision which is facially discriminatory may nonetheless avoid being declared null and void where the government is able to overcome the presumption of invalidity ‘by showing that the statute is a “compensatory tax” designed simply to make interstate commerce bear a burden already borne by intrastate commerce.’”



The court remanded the matter to the Court of Common Pleas of Montgomery County to hold a hearing and issue an “interim report” on whether the stock clause was a compensatory tax.



Montgomery County President Judge Joseph A. Smyth issued an interim report in October 1998, ruling that the portion of the stock clause which excludes from the personal-property tax stock held in companies which are subject to the capital stock and franchise taxes is unconstitutional.



But Smyth said the high court need not strike down the statute in its entirety, because the language of the statute that made it constitutionally offensive could be severed, leaving a personal-property tax which applied to all classes of stock, whether they are held in in-state or out-of-state corporations.



That having been said, Smyth also recommended that the counties should be able to keep the tax which had been previously collected under the stock clause.



“In arriving at this conclusion, President Judge Smyth stated that once the unconstitutional exclusion was severed from the stock clause, leaving a tax which was applicable to stock held in either out-of-state or in-state entities, then a valid tax remained; President Judge Smyth reasoned that in that event, the ‘counties should be permitted to retain and collect the personal property tax on stock that is not subject to the capital stock or franchise taxes.’”



In the justices’ latest opinion, they accepted most of Smyth’s recommendations.

Compensatory Tax Rejected

For a tax to be considered a valid compensatory tax, the state must establish three things, the court said.



* The government must identify the intrastate tax burden for which the facially discriminatory tax is compensating.



* The government must show that the tax on interstate commerce approximates, but does not exceed, the amount of the tax on intrastate commerce.



* The government must show that the events on which the interstate and intrastate taxes are imposed must be substantially equivalent.



“The three prong Fulton [Corp. v. Faulkner, 516 U.S. 325 (1996),] test is stated in the conjunctive; thus failure to meet one of any of the three prongs results in a finding that the governmental entity has failed to meet its burden in establishing that the discriminatory tax is nonetheless valid as a compensatory tax,” the court said.



The counties claimed that the stock clause is part of a comprehensive taxing scheme established to compensate for the taxes exacted by the capital stock and franchise taxes. The court rejected that argument, finding the legislative history of the personal-property tax law did not support it.



“President Judge Smyth concluded that history shows that these taxes ‘developed independent of each other through their histories … [and that] at no time was there a correlation between the taxes,” the court noted.



The court adopted Smyth’s finding on this point. The court said it also rejected the argument because the counties did not establish that the stock clause tax is fairly related to the services provided by the counties which benefit interstate commerce, a requirement under the first prong.



The court continued that even if it concluded the counties satisfied the first prong, they could not have met their burden as to the remaining two prongs of the Fulton test.



The court said it was not persuaded by the counties’ expert witness’ testimony that the tax imposed by the facially discriminatory stock clause “roughly approximates, but does not exceed” the amount of the tax burden which the capital stock tax and the franchise tax impose.



And with regard to the third prong, the court adopted Smyth’s conclusion that the personal-property tax is not substantially equivalent to the capital stock and franchise taxes.



Smyth had credited the Annenbergs’ witness’ testimony that the personal-property tax is based on the value of shares on one day, while the capital stock and franchise taxes are determined by measuring economic flow. In addition, the personal-property tax is imposed at the county level and is used for county purposes, whereas the capital stock and franchise taxes are imposed at the state level and are used for state purposes.



Because the counties failed to establish that the tax was a compensatory tax, the court ruled that “the portion of the stock clause which excludes from the personal-property tax stock held in companies which are subject to the capital stock and franchise taxes is unconstitutional.”



But that did not end the court’s inquiry. In the next step of the analysis, the court concluded the exclusionary language in the stock clause that makes it unconstitutional could be severed.

Excising the Unconstitutional