Amicus Curiae Brief — Nebraska Dept. of Revenue v. Loewenstein

IOTION FILED

MAY 3 320+ No. 93-823

ane

In THE

Supreme Court of the United States

OCTOBER TERM, 1993

STATE OF NEBRASKA, DEPARTMENT OF REVENUE,

Petitioner,

v.

JOHN LOEWENSTEIN,

Respondent.

On Writ of Certiorari to the Supreme Court of Nebraska

MOTION FOR LEAVE TO FILE BRIEF AND BRIEF OF

THE COUNCIL OF STATE GOVERNMENTS,

NATIONAL CONFERENCE OF STATE LEGISLATURES,

INTERNATIONAL CITY/COUNTY

MANAGEMENT ASSOCIATION,

NATIONAL LEAGUE OF CITIES,

NATIONAL ASSOCIATION OF COUNTIES,

U.S. CONFERENCE OF MAYORS,

AND NATIONAL GOVERNORS’ ASSOCIATION

AS AMICI CURIAE IN SUPPORT OF PETITIONER

RICHARD RUDA *

Chief Counsel

LEE FENNELL

STATE AND LOCAL LEGAL CENTER

444 North Capitol Street, N.W.

Suite 345

Washington, D.C. 20001

(202) 434-4850

* Counsel of Record for the

Amici Curiae

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in legal issues that affect state and local governments.

Among the most important of such issues are those in-

volving the scope of federal limitations on state and local

taxing authority. The Nebraska Supreme Court’s read-

ing of 31 U.S.C. § 3124 would prohibit state taxation of

mutual fund income derived from repurchase agreements

involving federal securities, and would thereby eliminate

a source of tax revenue currently relied upon by many

States.* Moreover, the Nebraska Supreme Court’s inter-

* Express judicial or administrative authority supports the taxa-

tion of repurchase income in many States. See, e.g., Department of

Revenue v. Page, 541 So.2d 1270 (Fla. Dist. Ct. App. 1989) ; Andras

v. Illinois Dep’t of Revenue, 506 N.E.2d 439 (Ill. App. Ct. 1987),

cert. denied, 485 U.S. 960 (1988); Hammond Lead Products v.

State of Indiana Tax Comm'rs, 575 N.E.2d 998 (Indiana 1991) ;

Everett v. Department of Revenue and Finance, 470 N.W.2d 13

(Iowa 1991) ; Comptroller v. First United Bank, 578 A.2d 192 (Md.

1990); Massachusetts Ltr. Rul. 81-82 (Sept. 1, 1981), 1991 Mass.

Tax LEXIS 39; Michigan Ltr. Rul. 87-68 (June 6, 1987), 1987

Mich. Tax LEXIS 114; Massman Constr. v. Director of Revenue,

765 S.W.2d 592 (Mo. 1989); Trust for Short-Term U.S. Govern-

ment Securities v. Minnesota Dep’t of Revenue, No. 89-1317 (Dist.

Ct. Hennepin County 1989); New York Tech. Servs. Mem. TSB-M-

88-(5)I (June 8, 1988), cited in TSB-A-89-(4)I, 1989 N.Y. Tax

LEXIS 311; N.C. Admin. Code tit. 17, r. 06B.0116(1); Pastore v.

Limbach, Ohio Bd. of Tax Appeals, No. 89-G-310 (May 3, 1991),

reprinted in 27 Ohio Tax Reports (CCH) { 400-916 (Sept. 16, 1991),

1991 Ohio Tax LEXIS 835; Oklahoma Tax Comm’n 89-09-26-16/

Prec. (Sept. 26, 1989), 1989 Okla. Tax LEXIS 24; Borg v. Depart-

ment of Revenue, 774 P.2d 1099 (Or. 1989); South Carolina Rev.

Rul. 91-15 at 6-7 (Sept. 18, 1991), 1991 S.C. Tax LEXIS 58; Capital

Preservation Fund, Inc. v. Wisconsin Dep’t of Revenue, 429 N.W.2d

551 (Wis. App. 1988); In re Thomas C. Sawyer Estate, 546 A.2d

784 (Vt. 1987); Re: Ruling Request—Ezempt Interest and Divi-

dends, P.D. 87-186 (Cir. Ct. Buchanan County, Va.) (July 7, 1987),

1987 Va. Tax LEXIS 107.

The Federation of Tax Administrators anticipates publishing a

report containing complete data on state tax treatment of repur-

chase agreement income received through mutual funds. Federa-

tion of Tax Administrators, State Taxation of Income from Mutual

Funds or Money Market Accounts Invested in U.S. Government

Securities: A Revised Report (forthcoming Summer 1994).

pretation would stretch the doctrine of intergovernmental

tax immunity to unprecedented lengths by extending it to

taxes that consider neither a federal obligation nor inter-

est on a federal obligation.

Because amici and their members have a compelling

interest in these issues, amici submit this brief to assist

the Court in its resolution of this case.

Respectfully submitted,

RICHARD RUDA *

Chief Counsel

LEE FENNELL

STATE AND LOCAL LEGAL CENTER

444 North Capitol Street, N.W.

Suite 345

Washington, D.C. 20001

(202) 434-4850

* Counsel of Record for the

May 3, 1994 Amici Curiae

QUESTION PRESENTED

Whether a state tax imposed on mutual fund share-

holder income derived from repurchase agreements in-

volving federal securities violates 31 U.S.C. § 3124 or

the constitutional doctrine of intergovernmental tax im-

munity.

(i)

TABLE OF CONTENTS

Page

QUESTION PRESENTED ............ i

TABLE OF AUTHORITIES sivwibisalieiinastitbitiatiababtahalnmin v

INTEREST OF THE AMICI CURIAE ..................... 1

ET iiciccienteliidincichatiatininaissttidadnenesiainningmaiietion 1

SUMMARY OF ARGUMENT 0 ceeeee 4

I et itintiitendipiieicntinerinitegipitbepecticcatinenenes 6

STATUTORY AND CONSTITUTIONAL PRIN-

CIPLES OF INTERGOVERNMENTAL TAX

IMMUNITY DO NOT PROHIBIT STATES FROM

TAXING INCOME OF MUTUAL FUND SHARE-

HOLDERS DERIVED FROM REPURCHASE

AGREEMENTS INVOLVING FEDERAL SECU-

A. State Taxes Imposed On Mutual Fund Income

Derived From Repurchase Agreements Do Not

Violate Section 3124, Because Their Computation

Does Not Require Consideration Of A Federal

Obligation Or The Interest On A Federal Obli-

B. The Taxation Of Repurchase Agreement Income

Does Not Interfere With The Borrowing Power

Of The Federal Government Or The Investment

Attractiveness Of Federal Obligations In Viola-

tion Of Section 3124 Or Principles Of Intergov-

ernmental Tax Immunity -..............-.-................ 12

1. There Is No Evidence That State Taxation

Of Repurchase Income Impedes The Borrow-

ing Power Of The Federal Government Or

Reduces The Investment Attractiveness Of

Federal Securities ..2..0.00.0.......0.0..cccceeceeceeeeeeeee 13

iv

TABLE OF CONTENTS—Continued ‘

age

2. An Attenuated Impact On Borrowing Power

Or Investment Attractiveness Would Be In-

sufficient To Confer Tax Immunity On Repo

Income Under Section 3124 Or The Consti-

Ce, .._..nrcssiinrnstnemsnrneitetlimninaniadenibenniemmiatiatndmente 18

C. Principles Of Intergovernmental Tax Immunity

Require That The Federal Tax Treatment Of

Repurchase Income Involving Municipal Bonds

Be Analyzed In The Same Manner As State Tax

Treatment Of Repurchase Income Involving

Federal Obligations —......................cc.ccc--sseseeeseeeeeee 24

CONCLUSION ..q..222.00c0ceo-cesessecsecsecssccsccccsscseotecsensecnensenssessooss 26

v

TABLE OF AUTHORITIES

Cases Page

American Bank and Trust Co. v. Dallas County,

468 U.S. 855 (1988) 2.2.0... ee eee eee 8,10, 11

American Nat’l Bank of Austin v. United States,

421 F.2d 442 (5th Cir.), cert. denied, 400 U.S.

IR 6 LT ne a eR 25

California State Bd. of Equalization v. Sierra Sum-

mit, Inc., 490 U.S. 844 (1989) 00000... occccccceeceeee 12

Commissioner of Internal Revenue v. P.G. Lake,

Ine., 356 U.S. 260 (1958) 22... cceeeeeeeeeeee 10

Denman v. Slayton, 282 U.S. 514 (1981) 0.0000. 23, 25

Educational Films Corp. v. Ward, 282 U.S. 379

8 lathe sc ty Sia le aE ate 24

First Nat’l Bank of Atlanta v. Bartow County

Bd. of Tax Assessors, 470 U.S. 588 (1985)........ passim

Gilmore v. State Board of Administration of Flor-

ida, 382 So. 2d 861 (Fla. Dist. Ct. App. 1980)... 16

Graves v. New York ex rel. O’Keefe, 306 U.S. 466

peat erent etka RRO, 7-8, 17-18, 21-22

Gregory v. Helvering, 298 U.S. 465 (1935) ............. 10

Helvering v. F & R Lazarus & Co., 308 U.S. 252

I a 10

Helvering v. Gerhardt, 304 U.S. 405 (1988) ............ 22

In re Bevill, Bresler & Schulman Asset Manage-

ment Corp., 67 B.R. 557 (D.N.J. 1986) ............... passim

James v. Dravo Contracting Co., 302 U.S. 1384

RRR SE NN Rea 2 AG Nl SR aS ae 7, 20, 25

McCulloch v. Maryland, 17 U.S. (4 Wheat) 316

SRE, i a A RES SO Bn RE 7,24

Michelin Tire Corp. v. Wages, 423 U.S. 276 (1976).. 6

Missouri v. Gehner, 281 U.S. 318 (1980) ............. 23

Plummer v. Coler, 178 U.S. 115 (1900) 000000000000... 18, 24

Rockford Life Ins. Co. v. Ill. Dep’t of Revenue,

tS Ae ETT passim

Smith v. Davis, 323 U.S. 111 (4944) —.....000.00...... passim

South Carolina v. Baker, 485 U.S. 505 (1988)......... 6, 24

Union Planters Nat'l Bank of Memphis v. United

States, 426 F.2d 115 (6th Cir.), cert. denied,

RE WUE: TET TIENT cc cthcdicrcmnssnsesedertsesesctsuiteesentensse 28, 25

vi

TABLE OF AUTHORITIES—Continued

Page

United States v. Atlas Life Insurance Co., 381 U.S.

United States v. California, 118 S.Ct. 1784 (1993).. 20

United States v. New Mexico, 455 U.S. 720 (1982).. 6, 7,

20, 21

Willeuts v. Bunn, 282 U.S. 216 (1981) ................... 9-10, 20

Statutes

EERE STE AE es LS: et passim

Bankruptcy Amendments and Federal Judgeship

Act of 1984, Pub. Law No. 98-353, § 396(a),

1984 U.S.C.C.A.N. (98 Stat.) 333, 366 (codified

SED cccenstsrniccomeitastontininaniedaitiin 14-15

Legislative Materials

Bankruptcy Law and Repurchase Agreements:

Hearing on H.R. 2852 and H.R. 3418 Before the

Subcomm. on Monopolies and Commercial Law

of the House Comm. on the Judiciary, 98th Cong.,

SD I, ' TEI vccnctnniernieenetenettiananiaeansial 14, 15, 15-16

Bankruptcy Reform: Hearing Before the Subcomm.

on Courts of the Senate Comm. on the Judiciary,

98th Cong., ist Sess. (1968) ................................ 14

H.R. Rep. No. 651, 97th Cong., 2d Sess., reprinted

Rt FS Ras RTE 7

Other Authorities

William F. Hagerty, IV, Note, Lifting the Cloud of

Uncertainty Over the Repo Market: Characteri-

zation of Repos as Separate Purchases and Sales

of Securities, 37 Vand. L. Rev. 401 (1984) .......... 3

Elizabeth M. Osenton, Note, The Need for a Uni-

form Classification of Repurchase Agreements:

Reconciling Investor Protection With Economic

Reality, 36 Am. U. L. Rev. 669 (1987) ............... 9, 15,17

Marcia Stigum, The Money Market (3d ed. 1990) ..2, 9, 17

Marcia Stigum, The Repo and Reverse Markets

In THE

Supreme Court of the United States

OCTOBER TERM, 1993

No. 93-823

STATE OF NEBRASKA, DEPARTMENT OF REVENUE,

3 Petitioner,

JOHN LOEWENSTEIN,

Respondent.

On Writ of Certiorari to the Supreme Court of Nebraska

BRIEF OF THE COUNCIL OF STATE GOVERNMENTS,

NATIONAL CONFERENCE OF STATE LEGISLATURES,

INTERNATIONAL CITY/COUNTY

MANAGEMENT ASSOCIATION,

NATIONAL LEAGUE OF CITIES,

NATIONAL ASSOCIATION OF COUNTIES,

U.S. CONFERENCE OF MAYORS,

AND NATIONAL GOVERNORS’ ASSOCIATION

AS AMICI CURIAE IN SUPPORT OF PETITIONER

INTEREST OF THE AMICI CURIAE

The interest of the amici is set forth in the motion

accompanying this brief.

STATEMENT

Amici adopt petitioner’s statement of the case, and

provide only the following discussion of points relevant

to amici’s argument.

2

A repurchase agreement or “repo” is a two step trans-

action, both parts of which are agreed to by the parties

“at the outset. See J.A. 11-12 94 10-12. In the first step,

Party A provides funds to Party B, in exchange for se-

curities owned by B. J.A. 11 411." The amount which

A gives B is typically less than the amount the securities

owned by B are actually worth. Marcia Stigum, The

Money Market 580 (3d ed. 1990); J.A. 12 94 15-17;

J.A. 33-34. In step two, A returns the securities to B,

and B returns the funds to A, along with “interest”—an

amount representing the value of B’s use of the funds for

the elapsed period of time. Stigum, The Repo and Re-

verse Markets at 26; J.A. 12 412. This “interest” is the

repo income which Nebraska, like most other States, seeks

to tax.

___ The rate of interest paid in connection with the repur-

chase transaction “does not bear any relationship to the

interest rate or yield paid on the underlying security, but

rather is based on the prevailing market rate paid on in-

vestments or financing transactions of similar maturity

and risk.” In re Bevill, Bresler & Schulman Asset Man-

agement Corp., 67 B.R. 557, 567 (D.N.J. 1986). The

interest paid on the securities themselves by the federal

government is at all times considered the income of the

original owner of the securities. If the lender duyer re-

ceives such interest on the securities during the repurchase

term, it is handed over to the original owner. See Stigum,

The Repo and Reverse Markets at 319; J.A. 69 4 9.

Although denominated a “repurchase,” there is gen-

eral agrecmuent throughout the financial community that

the transaction operates, in economic essence, like a col-

lateralized loan. See, e.g., Stigum, The Money Market

1 Although the securities involved in this case are federal securi-

ties, municipal bonds and other instruments may also be the subject

of repurchase agreements. See discussion infra at 24-26; Marcia

Stigum, The Repo and Reverse Markets 333-34 (1989) (discussing

litigation involving municipal bond repos); Marcia Stigum, The

Money Market 587 (3d ed. 1990).

3

at 577 (“Despite the fact that repos and reverses take the

form of sequential sales and repurchases of securities,

everyone on the Street agrees that the economic essence

of the transaction is that it is a collateralized loan, not

a pair of securities trades.”).

The Federal Reserve Board participates in repurchase

agreements to effect short-term adjustments in the nation’s

money supply. See generally Marcia Stigum, The Repo

and Reverse Markets 90-96 (1989); William F. Hagerty,

IV, Note, Lifting the Cloud of Uncertainty Over the Repo

Market: Characterization of Repos as Separate Purchases

and Sales of Securities, 37 Vand. L. Rev. 401, 403-04

(1984). Repurchase agreements which do not involve

the Fed, however, do not serve this purpose. Such repos

are viewed as alternatives to other forms of credit for

the parties involved, and are used either to obtain the use

of funds for a short time period, or to invest funds for

short-term use by another party. See Stigum, The Repo

and Reverse Markets at 107-110, 312-313; Hagerty,

Lifting the Cloud of Uncertainty, 37 Vand. L. Rev. at

404,

This case involves Nebraska’s efforts to tax income de-

rived from private repurchase agreements entered into by

two mutual funds, the Trust for Short Term U.S. Gov-

ernment Securities and the Trust for U.S. Treasury Obli-

gations (the “Trusts”). Pet. 2-3. There has been no sug-

gestion that the Fed was a party to any of the repurchase

agreements at issue here. Indeed, Loewenstein describes

the Trusts in which he invested as “secondary dealers,”

see Opp. 8; such “secondary dealers do not deal directly

with the Federal Reserve.” Bevill, 67 B.R. at 568; see

Opp. 8.

4

SUMMARY OF ARGUMENT

1. Section 3124 prohibits any form of state taxation

that “would require the [federal] obligation, the interest

on the obligation, or both, to be considered in comput-

ing a tax... .” 31 U.S.C. §3124(a). The tax which

Nebraska has imposed upon mutual fund income derived

from repurchase agreements involving federal securities

falls outside the scope of this prohibition, because it does

not consider the underlying federal obligation or interest

paid on that obligation. Instead, the income earned in

connection with a repurchase agreement represents the

value associated with the use of a sum of money for a

given period of time. See Stigum, The Repo and Reverse

Markets at 26 (“The difference between the purchase and

sale prices on the repo transaction is the interest the in-

vestor earns on his loan.”).

Whether a repurchase agreement is characterized in

accordance with its clear economic purpose and effect

(i.e., as a loan collateralized by a federal obligation), or

viewed as unique hybrid transaction that involves a

matched sale and repurchase designed to achieve the same

effect as a loan, money paid in connection with a private

repo reflects one thing only—the value associated with

the use of a sum of money for an agreed period of time.

By construing Section 3124 to exempt income from such

private transactions from state taxation, the Nebraska

Supreme Court flatly disregarded this Court’s repeated

admonition that the statutory exemption not be “expanded

or modified in any degree by the judiciary[.]” Rockford

Life Ins. Co. v. Illinois Dep’t of Revenue, 482 U.S. 182,

191-92 (1987) (quoting Smith v. Davis, 323 U.S. 111,

119 (1944)).

2. Respondent relies on an erroneous interpretation

of language in Smith to argue that repo income is en-

titled to tax-exempt status under Section 3124. There,

in assessing the types of government obligations encom-

passed within Section 3124’s prohibition, the Court noted

5

“the long established Congressional intent to prevent

taxes which diminish in the slightest degree the market

value or investment attractiveness of obligations issued by

the United States in an effort to secure necessary credit.”

323 U.S. at 117. Respondent’s attempt to translate that

statement into a ban on state taxation of repo income is

unavailing for two reasons.

First, no evidence has been presented in this case that

would indicate a State’s taxation of repo income would

have any deleterious effect on the “market value” or “in-

vestment attractiveness” of federal obligations. The affi-

davit of Peter D. Sternlight, upon which respondent and

the Nebraska Supreme Court place primary reliance, see

Opp. 7-9 & App. A; Pet. App. 7-8, was prepared for a

bankruptcy proceeding and contains no evidence what-

soever as to the effect of state taxation on the repo mar-

ket, and offers no opinion on that subject. Moreover,

because repos are uniquely attractive investment instru-

ments which have no close substitutes, it is unlikely that

state taxation would cause investors to turn away from

them in sufficient numbers to have any impact on the

market for the underlying federal obligations.

Second, respondent’s reading of the statement in Smith

is inconsistent with precedents of this Court, both before

and after Smith, holding that an attenuated or indirect

effect on the federal government’s borrowing power is in-

sufficient to confer immunity from taxation. See, ¢.g.,

Rockford, 482 U.S. at 190. Moreover, the Court has

repeatedly declined to read intergovernmental tax immu-

nity doctrines as sheltering otherwise taxable income.

See, e.g., First Natl Bank of Atlanta v. Bartow County

Bd. of Tax Assessors, 470 U.S. 583, 595-96 (1985).

The Court has never required States to go beyond the

statutory and constitutional requirements to grant addi-

tional tax advantages to holders of federal securities and

those with whom they deal; failure to grant such added

advantages does not “diminish” the attractiveness of the

obligations in the sense prohibited by Section 3124.

6

3. Granting tax-exempt status to repo income involv-

ing federal obligations will create a double standard in

violation of principles of i=tergovernmental tax immunity

unless repo income involving municipal bonds is similarly

exempted from federal taxation. In analyzing assertions of

tax immunity involving either the federal government or

State and local governments, the Court uses the same

standard to determine “whether a tax is ‘on’ a govern-

ment.” South Carolina v. Baker, 485 U.S. 505, 518 n.11

(1988). Hence, if principles of intergovernmental tax

immunity are held to require the serious encroachment

on the taxing power of the States urged by respondent,

they would also necessarily require that the same limita-

tion be placed on the taxing power of the federal govern-

ment where repos involving municipal bonds are con-

cerned, thereby calling into question the validity of a line

of federal appellate cases holding to the contrary.

ARGUMENT

STATUTORY AND CONSTITUTIONAL PRINCIPLES

OF INTERGOVERNMENTAL TAX IMMUNITY DO

NOT PROHIBIT STATES FROM TAXING INCOME

OF MUTUAL FUND SHAREHOLDERS DERIVED

FROM REPURCHASE AGREEMENTS INVOLVING

FEDERAL SECURITIES

The modern doctrine of intergovernmental tax immu-

unity rests on the core tenet that “absent congressional

action, we have emphasized that the States’ power to tax

can be denied only under ‘the clearest constitutional man-

date.’” United States v. New Mexico, 455 U.S. 720, 738

(1982) (quoting Michelin Tire Corp. v. Wages, 423

U.S. 276, 293 (1976)). Because the Court has indicated

that Congress’ enactment of Section 3124 did not expand

the reach of intergovernmental tax immunity beyond its

narrow constitutional confines,? before examining that

2 The prior codification of Section 3124 was viewed as coextensive

with the constitutional doctrine of intergovernmental tax immunity.

See, e.g., First Nat’l Bank, 470 U.S. at 593 (“[T]his Court con-

7

statute it is appropriate to revisit “the underlying constitu-

tional principle” which it embodies. New Mexico, 455

U.S. at 733. That principle, as the Court has emphasized,

exists within “narrow constitutional limits,” id. at 737,

and serves a very specific, limited purpose—"“that of fore-

Stalling ‘clashing sovereignty,’ by preventing the States

from laying demands directly on the Federal Govern-

ment.” Jd. at 735 (quoting McCulloch v. Maryland, 17

U.S. (4 Wheat.) 316, 430 (1819)). Accordingly, the

Constitution prohibits only those taxes which “would be

‘a direct interference with the functions of government it-

self.” Jd. at 736 (quoting James v. Dravo Contracting

Co., 302 U.S. 134, 157 (1937)).

This “narrow approach to governmental tax immunity

accords with competing constitutional imperatives, by giv-

ing full range to each sovereign’s taxing authority.” /d.

at 735-36. And, as the Court explained in the landmark

case of Graves v. New York ex rel. O'Keefe, 306 U.S.

466 (1939), a narrow construction of intergovernmental

tax immunity is especially important to avoid unwarranted

encroachment on the taxing power of the other sovereign,

where, as here, the principle of intergovernmental tax

immunity is invoked for the benefit of a private citizen:

[T]he implied immunity of one government and its

agencies from taxation by the other should, as a prin-

ciple of constitutional construction, be narrowly re-

stricted. For the expansion of the immunity of the

one government correspondingly curtails the sover-

eign power of the other to tax, and where that

immunity is invoked by the private citizen it tends

to operate for his benefit at the expense of the taxing

sistently has ‘treated (§ 3701] as principally a restatement of the

constitutional rule.’”) (citations omitted). The legislative history

of the statutory provision’s 1982 recodification as Section 3124

indicates that no substantive change was intended. See id. at 585

n.1; H.R. Rep. No. 651, 97th Cong., 2d Sess. 94, reprinted in 1962

U.S.C.C.A.N. 1895, 1988.

government and without corresponding benefit to the

government in whose name the immunity is claimed.

Id. at 483 (citations omitted). Here, the encroachment

on the taxing power of the States proposed by respondent

cannot be squared with this limited constitutional prin-

ciple of intergovernmental tax imieurity. Because Section

3124 is no broader in scope than ‘).s underlying constitu-

tional principle, an analysis of the Nebraska tax under

this statute yields the same conclusion.

A. State Taxes Imposed On Mutual Fund Income Derived

From Repurchase Agreements Do Not Violate Section

3124, Because Their Computation Does Not Require

Consideration Of A Federal Obligation Or The Interest

On A Federal Obligation

Section 3124 clearly defines the scope of the tax ex-

emption at issue here: A state or local government is

prohibited from imposing any “fotm of taxation that

would require the [United States government] obligation,

the interest on the obligation, or both, to be considered

in computing a tax... .” 31 U.S.C. §3124(a). The

plain meaning of this statutory provision is that a state

or local government may not “take[] into account, or

include[] in the accounting” the value of the federal obli-

gation itself or the interest earned on that obligation in

determining tax liability. American Bank and Trust Co.

v. Dallas County, 463 U.S. 855, 862 (1983).

Computation of the Nebraska tax on Loewenstein’s in-

come does not require consideration of any federal obliga-

tion or the interest on any federal obligation. Income

derived from repurchase agreements is paid for the use

of money for a specified time period, and is unrelated to

the yield or interest rate of the underlying security. See

Stigum, The Repo and Reverse Markets at 318; Bevill,

67 B.R. at 567. Repo income represents a sum paid for

the use of the money, not interest paid by the federal

government on the underlying exempt obligation. Even

during the repurchase term, the interest paid on the fed-

9

eral obligation itself (which is, of course, not subject to

taxation by Nebraska) is passed through to

owner of the securities. See Stigum, The R

verse Markets at 319; J.A. 69 4 9.

as the ones implicated here, the transaction is designed to

do nothing more than permit one party to have the use

of a given sum of money for a specified period of time.

See page 3, supra; Stigum, The Repo and R

Markets at 107-110.

Whatever its form, the economic substance of a repur-

chase, like that of any arrangement designed to allow one

party to use funds provided by another party for a given

period of time, is a loan. See, e.g., Stigum, The Money

Market at 577; J.A. 30 (Sternlight deposition); Elizabeth

M. Osenton, Note, The Need For A Uniform Classifica-

tion Of Repurchase Agreements: Reconciling Investor

Protection With Economic Reality, 36 Am. U. L. Rev.

669, 689 (1987). The federal obligation is not “pur-

chased” or “sold” in any economically meaningful sense;

instead, it serves as collateral for a loan. This becomes

clear when key factors such as the risks borne by each

party, the “sales” price, the amount of “interest” paid,

and the treatment of interest on the underlying security,

are considered. The way in which these features are

handled in the repurchase transaction is economically ex-

plicable only when the transaction is viewed as a col-

lateralized loan. See, e.g., Stigum, The Repo and Reverse

Markets at 311-32; Pet. Br. at 23-32."

* Even if the Court were to view the repurchase agreement as a

purchase and sale of a federal obligation, however, Loewenstein

would still not be entitled to a tax exemption. If the transaction were

characterized in this manner, the difference between the amount he

initially “paid” for the federal security and the amount he ulti-

mately “sold” it back for would represent a capital gain. Capital

gains on federal obligations are not tax exempt. Because such

“gain({s} may be regarded as ‘the creation of capital, industry and

skill,’ ” a tax on them is not “on the obligations of the [government],

or on the investment therein” and does not violate principles of

intergovernmental tax immunity. Willeuts v. Bunn, 282 U.S. 216,

10

As this Court has noted, it is the economic substance

of a transaction that controls its treatment for tax pur-

poses rather than the form that the transaction takes. “In

the field of taxation, administrators of the laws and the

courts are concerned with substance and realities .. . .”

Helvering v. F & R Lazarus & Co., 308 U.S. 252, 255

(1939). See also Commissioner of Internal Revenue v.

P.G. Lake, Inc., 356 U.S. 260, 266-67 (1958) (sub-

stance of arrangements controls rather than form; “([t}heir

essence is determined not by subtleties of draftsmanship

but by their total effect”); Gregory v. Helvering, 293 U.S.

465, 469-70 (1935). This is consistent with Congress’

‘rejection, in the field of intergovernmental tax immunity,

of formal distinctions that are economically meaningless.

See American Bank and Trust Co., 463 U.S. at 862.

But whether or not the characterization of a repurchase

agreement as a collateralized loan is accepted, the fact

remains that repo income does not represent a federal

obligation or its interest, but income from a private trans-

action for the use of money for a given period of time.

Hence, even if this Court were to decide that a repur-

chase is better characterized as a purchase and resale,

rather than a loan, this characterization would not be

determinative for Section 3124 purposes.. Section 3124

does not provide a blanket immunity from taxation for

“owners” of federal securities; even an “owner” of a fed-

eral security is only entitled to exemption from taxes the

computation of which requires consideration of the fed-

eral security or the interest earned thereon. Regardless

of how a repo is characterized, the income that it gen-

erates stems from neither of these sources; instead it is

money that one party pays another for the privilege of

using money for a certain time period.

In arguing that Section 3124 nevertheless requires that

a tax exemption be granted repo income, respondent, like

228 (1931) (citation omitted) ; see Br. Am. Cur. State of California,

et al. at 13-17.

11

the Nebraska Supreme Court, relies on the statute’s prior

wording, which expressly banned every form of taxation

that required the federal obligation or interest on the

obligation to “be considered, directly or indirectly, in the

computation of the tax ....” See Pet. App. 9; Opp. 10.

This language, which was added in a 1959 amendment,

did away with formalistic distinctions having no basis in

economic reality, so as to ban taxes which were, in eco-

nomic effect, placed upon federal securities or the interest

earned thereon. See American Bank, 463 U.S. at 858,

862. Because Congress indicated that its 1982 recodifica-

tion of the statute (which omitted the words “directly or

indirectly”) was intended to work no substantive change,

see note 2, supra, respondent is correct in asserting that

Section 3124 continues to ban forms of taxation that

require the “indirect” consideration of a federal security

or the interest thereon.

_ Here, however, computation of Nebraska’s tax does not

involve even the “indirect” consideration of a federal

security or interest on a federal security—the interest paid

in connection with a repurchase is paid for use of a sum

of money for a period of time and represents neither a

federal security nor its interest or yield. The Nebraska

Supreme Court reached the opposite result only by strip-

ping the word “indirectly” of its statutory context and

reading it as an open-ended ban on any tax placed on

income even “indirectly” linked to a federal obligation.

As the Court made clear in First National Bank, however,

the words “directly or indirectly” were not intended to

“broaden the scope” of the statutory prohibition beyond

its narrow constitutional bounds, but only “to abolish

the formalistic distinction between taxes on income and

taxes measured by income.” 470 U.S. at 593-94. Hence,

the 1959 amendment did not exempt additional forms of

income from state taxation; it only clarified that States

were precluded from imposing any form of taxation,

whether direct or indirect, on those narrow categories of

income set forth in the statute. See id. at 594 (no indica-

12

tion in legislative history “that Congress understood the

addition actually to broaden the scope of the exemption,

as well as to clarify the forms of taxes to which the ex-

emption applied” ).

The Nebraska Supreme Court's extension of tax-immune

status to repurchase agreements, despite Section 3124's

clear language limiting the tax exemption to federal obli-

gations and interest on federal obligations, represents pre-

cisely the type of judicial broadening of intergovermental

tax immunity that the Court has repeatedly warned against.

As the Court admonished in Smith, Congress’ “intent to

immunize from state taxation only the interest-bearing

obligations of the United States which are needed to

secure credit to carry on the necessary functions of gov-

ernment[,] . . . . which is largely codified in § 3701,

should not be expanded or modified in any degree by the

judiciary.” 323 U.S. at 119, quoted in Rockford, 482

U.S. at 191-92. See also California State Bd. of Equali-

zation v. Sierra Summit, Inc., 490 U.S. 844, 851-52

(1989) (“[Wle have stated that ‘[a] court must proceed

carefully when asked to recognize an exemption from

state taxation that Congress has not clearly expressed.’ ” )

(citing Rockjord, 482 U.S. at 191). Cf. Smith, 323 US.

at 117 (“Tax exemptions being the exception rather than

the rule, much clearer language evidencing an intent to

immunize open account claims under Section 3701 is nec-

essary under these circumstances.” ).

B. The Taxation Of Repurchase Agreement Income Does

Not Interfere With The Borrowing Power Of The

Federal Government Or The Investment Attractiveness

Of Federal Obligations In Violation Of Section 3124 Or

Principles Of Intergovernmental Tax Immunity

Despite the clearly limited language of Section 3124,

respondent argues that this Court has read the provision

in a manner that would nonetheless shield repo income

from taxation. Specifically, respondent relies on this

Court’s statement in Smith, referencing “the long estab-

13

lished Congressional intent to prevent taxes which dimin-

ish in the slightest degree the market value or investment

attractiveness of obligations issued by the United States

in an effort to secure necessary credit.” 323 U.S. at 117.

Respondent then contends that Nebraska’s taxation of

repo income falls within this prohibition because it would

impair the federal government's borrowing capacity and

the attractiveness of its obligations. This argument is

unavailing for two reasons: there is no evidence to sup-

port it, and it is based on a misreading of this Court's

precedents.

1. There Is No Evidence That State Taxation Of

Repurchase Income Impedes The Borrowing Power

Of The Federal Government Or Reduces The Invest-

ment Attractiveness Of Federal Securities

Both respondent and the Nebraska Supreme Court rely

primarily on testimony of Peter D. Sternlight, Executive

Vice President of the Federal Reserve Bank of New York

(FRBNY), that was submitted in another case, in con-

tending that Nebraska's taxation of repurchase income

impedes the borrowing power of the federal government

and makes federal securities less attractive. See Opp. 7-9

& App; J.A. 22-43. But Sternlight’s affidavit, which was

prepared in the context of a bankruptcy proceeding, to-

tally fails to support respondent’s contention or the Ne-

braska Supreme Court’s conclusion.‘

_ Most importantly, Sternlight’s affidavit offers no opin-

ion whatsoever as to the effect of state taxation on re-

* As the Nebraska Supreme Court explained, the testimony of

Peter Sternlight upon which it relied was given in a deposition

conducted in another case invoiving the same issue, Page v. Depart-

ment of Revenue, State of Florida, No. Cl 87-2586, which was

litigated in the Circuit Court of the Ninth Judicial Circuit, Orange

County, Florida. Pet. App. 7. That deposition, however, centered

on an affidavit which Sternlight had prepared in connection with

yet another proceeding, Bevill, 67 B.R. 557, a bankruptcy case.

See = 23-28 (Sternlight deposition); J.A. 39-43 (Sternlight

14

purchase agreements. This is not surprising, since the affi-

davit was prepared in a case involving a bankruptcy ques-

tion. The “hobbling of the repo market” warned of in

47 of the affidavit, J.A. 42, references not the effect of

taxation, as respondent would have this Court believe,

but uncertainty as to the effect of bankruptcy on repur-

chase agreements. This is clear not only from the context

in which the affidavit was prepared, but also from the

fact that Sternlight’s testimony in a Congressional hearing

involving proposed bankruptcy amendments tracks, al-

most verbatim, his statements in this portion of the affi-

davit. Compare Bankruptcy Reform: Hearing Before the

Subcomm. on Courts of the Senate Comm. on the Judi-

ciary, 98th Cong., Ist Sess. 314-15 (Statement of Peter

D. Sternlight) (1983) [hereinafter Senate Hearing] with

J.A. 42 4 7.

In the Senate Hearing, Sternlight outlined the problems

that could affect the repo market if the uncertainty sur-

rounding bankruptcy treatment were not resolved:

More generally, a hobbling of the repo market

could have broad rate effects throughout the financial

markets, diminishing efficiency in the allocation of

resources. Market participants would turn io less

liquid forms of investment or more costiy sources of

funds—in either case tending to produce higher rates

in the economy at large. Greater volatility of rates

as a consequence of a diminished repo market could

also add to average rate levels.

Id. Sternlight then went on to testify in the Senate Hear-

ing that these problems could best be resolved by “modi-

fy[ing] the Bankruptcy Code... .” Id. at 315.°

5 See also Bankruptcy Law and Repurchase Agreements: Hearing

on H.R. 2852 and H.R. 3418 Before the Subcomm. on Monopolies and

Commercial Law of the House Comm. on the Judiciary, 98th Cong.,

2d Sess. 50-58 (Statement of Peter D. Sternlight) (1984) [herein-

after House Hearing]. Statutory amendments to the Bankruptcy

Code have alleviated many of the liquidity concerns raised by Stern-

light in his testimony in Congressional hearings. See Bankruptcy

15

Sternlight’s response to questions involving taxation

further clarify that his testimony was not directed at the

consequences of tax treatment. During his deposition in

the Page case, he responded to a question about the fed-

eral tax treatment of repo income by disclaiming any

“expert familiarity” in that area. J.A, 31. Similarly, in a

letter submitted in connection with a Congressional hear-

ing involving proposed bankruptcy amendments, he indi-

cated that the amendments would have no effect on the

characterization of repurchase agreements for tax pur-

poses. See House Hearing at 106 (letter of Peter D.

Sternlight to Hon. Peter W. Rodino, Jr.) (“While I would -

not want to claim expertise on the treatment of repos for

tax purposes, it seems to me that the enactment of H.R.

2852 and 3418 should not affect the characterization of

repos under the tax laws ..: .”).

Nor does Sternlight’s affidavit suggest that the char-

acterization of repurchase agreements as loans for Section

31 24 purposes would trigger untoward consequences; his

discussion of the dangers of a “secured loan” characteri-

zation, see J.A. 41 45, were made in a case where the

characterization of repos for bankruptcy purposes was at

issue. The characterization for tax purposes, which is

based on the economic essence of a transaction, need not

be binding in other settings where factors other than eco-

nomic essence are important. Indeed, the Fed’s own char-

acterization of repos as sales and repurchases in the bank-

ruptcy context is not viewed as controlling in other con-

texts, such as taxation. See House Hearing at 106-07

(letter of Peter D. Sternlight) (“while the Federal Re-

serve has gone on record as favoring purchase-and-sale

characterization of repurchase agreements, that statement

Amendments and Federal Judgeship Act of 1984, Pub. Law No. 98-

353, § 396(a), 1984 U.S.C.C.A.N. (98 Stat.) 333, 366 (codified at

11 U.S.C. § 559); Osenton, The Need for a Uniform Classification,

36 Am. U. L. Rev. at 684 (“By passing section 559, Congress re-

resem ys liquidity that repo investors and the economy need and

expec ).

16

is limited to a bankruptcy context and should not be taken

as an endorsement of purchase-and-sale characterization

for tax, accounting, or other purposes”); see also Stigum,

The Repo and Reverse Markets at 325 (discussing con-

texts in which Fed “describes the repos it does as credit

transactions that add to bank reserves”).°

The Sternlight affidavit is not probative of the finding

of the court below that a “state tax on [repo] income

would diminish the market value and investment attrac-

tiveness of federal securities . . . [and] impose a burden

on the federal government's regulation of the nation’s

money supply.” Pet. App. A-13. It is therefore a wholly

insufficient basis for extending intergovernmental tax im-

munity to the repurchase agreement income of private

parties under the language of Smith v. Davis. The Court

has flatly rejected the notion that a prohibited effect on the

marketability or attractiveness of government obligations

can be inferred from the mere withdrawal of a tax benefit,

in the absence of supporting evidence. In First National

6 The idea that repos might be characterized differently in the

bankruptcy and taxation areas is easily explained. In the bank-

ruptey context, the parties’ intent is an important part of the

characterization determination, whereas in taxation, economic sub-

stance alone controls. See Bevill, 67 B.R. at 594 (distinguishing tax

cases characterizing repos as collateralized loans in. which courts

had found that “the parties’ intent underlying their contractual re-

lations was not relevant to the legal characterization of the transac-

tion for federal income tax purposes,” from bankruptcy cases in

which “the intent of the parties is a central consideration” and

“lcjonsiderations relating to the economic substance of the trans-

actions, while relevant to this determination, are certainly not con-

trolling”) (citations omitted). See also Gilmore v. State Board of

Administration of Florida, 382 So. 2d 861, 863 (Fla. Dist. Ct. App.

1980) (characteriz: ion of repurchase agreement applicable in de-

fault context might 1.0t be appropriate in tax context). The exclu-

sive focus on economic substance in the tax context is driven by

the need to preclude tax avoidance by the taxpayers through crea-

tive formulation or labelling of their dealings. See Bevill, 67 B.R.

at 594 (noting that the courts in tax cases “were concerned with

the tax avoidance possibilities associated with the transactions and

focused their attention solely on their economic substance”).

17

Bank, for example, the Court found that there was no

evidence indicating that the removal of a tax shelter

would be enough to “prompt banks to forgo the advan-

tages of federal obligations, such as their extreme liquidity

and safety, and to invest their money elsewhere.” 470

U.S. at 597.”

The same analysis applies here. Repurchase agree-

ments are a uniquely attractive financial tool in a wide

variety of investment contexts. See, e.g., Osenton, The

Need for a Uniform Classification, 36 Am. U. L. Rev.

at 670-71 (“Retail repos give investors what they want

most—liquidity, security, and high-yield.”) (footnote

omitted); Stigum, The Repo and Reverse Markets at

107-114 (describing unique attractiveness of repos for

different types of investors). Indeed, many investors, in-

cluding state and local governments, may be prohibited

from engaging in other types of investments and may

view repos as their most attractive alternative. See

Stigum, The Money Market at 589; J.A. 42-43, 48

(Sternlight affidavit). The absence of attractive substi-

tutes for repurchase agreements suggests that state tax

treatment is unlikely to influence many investors. Cf.

First Nat'l Bank, 470 U.S. at 597. In fact, many States

have taxed repurchase agreements for years, see footnote

to attached Motion, yet there is no indication that in-

vestors are turning to other alternatives as a result.

In the absence of any indication that state taxation of

repo income will adversely affect the federal government’s

borrowing power, there is no basis for the immunization

of private repurchase agreements from taxation. As the

Court explained in Graves, “it is plain that there is no

basis for implying a purpose of Congress to exempt the

7 The Court also noted that allowing the sheltering of ocherwise

taxable income under the auspices of $3701 could lead a State

to alter its tax strategy to place heavier reliance on the types of

taxes expressly exempted from § 3701’s prohibition on taxation:

this would make the net effect on investment attractiveness uncer-

tain. First Nat'l Bank, 470 U.S. at 596-97.

18

federal government or its agencies from tax burdens

which are unsubstantial or which courts are unable to

discern.” 306 U.S. at 480. And, as Rockford recently

reaffirmed,

[When effort is made, as is the case here, to estab-

lish the unconstitutional character of a particular

tax by claiming that its remote effect will be to im-

pair the borrowing power of the government, courts

in overturning statutes, long established and within

the ordinary sphere of state legislation, ought to have

something more substantial to act upon than mere

conjecture. The injury ought to be obvious and

appreciable.

482 U.S. at 190 n.10 (quoting Plummer v. Coler, 178

U.S. 115, 137-38 (1900)). There has been no showing

in this case of an obvious and appreciable impairment of

the power of the federal government.

2. An Attenuated Impact On Borrowing Power Or

Investment Attractiveness Would Be Insufficient To

Confer Tax Immunity On Repo Income Under Sec-

tion 3124 Or The Constitution

Contrary to the Nebraska Supreme Court’s holding and

respondent’s assertions, principles of intergovernmental

tax immunity do not require the automatic invalidation

of any state tax that might have even the slightest and

most attenuated impact on the federal government’s bor-

rowing power or on the investment attractiveness of fed-

eral obligations. Hence, even if there were some slight

marginal impact on the investment attractiveness of fed-

eral obligations flowing from Nebraska’s taxation of repur-

chase agreement income, this would not be determinative

as a matter of constitutional or statutory law. Respond-

ent’s contentions to the contrary are based on a misread-

ing of this Court’s precedents.

As a preliminary matter, it is quite significant that the

Court’s statement in Smith v. Davis regarding Congres-

sional intent to prohibit taxes that would “diminish in the

19

slightest degree the market value or the investment attrac-

tiveness of obligations issued by the United States in an

effort to secure necessary credit,” 323 U.S. at 117, was

made not in the context of forbidding taxes with an in-

direct or attenuated impact on government obligations,

but in the context of determining Congressional intent as

to the types of government obligations exempted from

taxation. The Court’s words can most fairly be read in

this context as emphasizing that Congress sought to pro-

tect the value of certain types of obligations (i.e., those

issued by the United States in an effort to secure neces-

sary credit) from being eroded through taxation, and

that it had therefore shielded such obligations (and only

such obligations) from taxation.

This reading is consistent with the language Congress

used to define the boundaries of the tax exemption, which

evidences no intent to encompass all taxation that is in-

directly linked to or that might affect, in even the most

highly attenuated fashion, a government obligation. Given

the Court’s insistence—in the very same paragraph of the

Smith decision—on clear language to evidence Congress’

intent to create a tax exemption, and its holding in Smith

that the challenged state tax did not violate either con-

stitutional or statutory principles of intergovernmental tax

immunity, it is wholly implausible that the Court intended

for its words to signal the vast and unprecedented expan-

sion of tax immunity attributed to them by respondent

and the court below. See 323 U.S. at 117. Indeed, it is

impossible to square either the Court’s holding or its clos-

ing admonition in the Smith case with such an interpre-

tation:

All of these related statutes are a clear indication of

an intent to immunize from state taxation only the

interest-bearing obligations of the United States

which are needed to secure credit to carry on the nec-

essary functions of government. That intent, which is

largely codified in Section 3701, should not be ex-

panded or modified in any degree by the judiciary.

20

Id. at 119 (emphasis added), quoted in Rockford, 482

U.S. at 191-92.

The Court’s holdings, in cases both prior and subse-

quent to Smith, further clarify that the fact that a tax

might have some attenuated impact on the value or attrac-

tiveness of federal obligations does not render it imper-

missible under statutory or constitutional principles of in-

tergovernmental tax immunity. See, e.g., Rockford, 482

U.S. at 190 (any possible effect that taxation of Ginnie

Maes might have on borrowing ability of the United

States was “far too attenuated to support constitutional

immunity”); Willcuts v. Bunn, 282 U.S. 216, 225 (1931)

(power to tax should not be needlessly crippled “where

no direct burden is laid upon the governmental instru-

mentality, and there is only a remote, if any, influence

upon the exercise of the functions of government”).*

Moreover, the Court has emphasized that “[t]he tax ex-

emption required by the Constitution and § 3701 is not

a tax shelter.” First Nat'l Bank, 470 U.S. at 597. Thus,

its statement in Smith v. Davis that every form of taxa-

tion is prohibited which would “diminish in the slightest

degree the market value or the investment attractiveness

of obligations issued by the United States,” must be read

as a prohibition only on affirmative tax erosion of the

8 Cf. United States v. New Mexico, 455 U.S. at 734 (Tax immu-

nity “may not be conferred simply because the tax has an effect on

the United States.”), quoted in Rockford, 482 U.S. at 191 n.11;

United States v. California, 113 S.Ct. 1784, 1788-89 (1998) (Al-

though the federal government “is absolutely immune from direct

taxes, it is not immune from taxes merely because they have an

‘effect’ on it, or ‘even because the Federal Government shoulders the

entire economic burden of the levy’... . Tax immunity is ‘appro-

priate in only one circumstance: when the levy falls on the United

States itself, or on an agency or instrumentality so closely con-

nected to the Government that the two cannot realistically be viewed

as separate entities.’”) (citations omitted); James v. Dravo Con-

tracting Co., 302 U.S. 184, 160 (1987) (fact that a tax imposed on

a government contractor may increase the cost to the government

does not render it invalid).

21

value of federal securities and the interest that they earn.

In other words, the baseline or starting point which may

not be diminished by taxation (and which Nebraska has

not sought to tax) is the federal obligation and the inter-

est that it earns. Clearly, a State does not violate prin-

ciples of intergovernmental tax immunity because it fails

to provide added tax benefits to holders of federal securi-

or those with whom they deal, simply because this

d be said to “diminish” the value or attractiveness of

federal security compared to what it might be if

those added tax benefits were granted.’

Such a failure to bestow extra tax advantages is obvi-

ously not the type of prohibited diminishment that the

attractiveness of federal obligations, even if true, suffers

from this same fallacy. Repo income does not represent

a federal obligation or interest earned thereon, and hence

is not part of the baseline protected by constitutional and

Statutory principles of intergovernmental tax immunity.

States are not required to maximize the attractiveness of

federal obligations by granting special tax benefits to all

who come into contact with them; they are only required

to abide by the constitutional and statutory rule that taxa-

tion not erode the value of the federal obligations them-

selves or the interest that the obligations generate and

thereby constitute “a direct interference with the func-

tions of government itself.” New Mexico, 455 U.S. at

736 (citation omitted).

As the Court explained in Graves, in the context of

taxes imposed on government employees, the

* For example, it is obvious that exempting holders of federal

obligations from state income tax on any of their earnings (whether

related to the federal obligations or not) would make holding a

federal obligation more attractive. Consequently, failing to provide

those benefits could be said to “diminish” the attractiveness of the

obligations compared to the attractiveness they would enjoy if those

benefits were provided.

22

purpose of [intergovernmental tax] immunity was not

to confer benefits on the employees by relieving them

from contributing their share of the financial support

of the other government, whose benefits they enjoy,

or to give an advantage to that government by enab-

ling it to engage employees at salaries lower than

those paid for like services by other employers, public

or private, but to prevent undue interference with

the one government by imposing on it the tax bur-

dens of the other.

306 U.S. at 483 (footnote omitted) (citing Helvering v.

Gerhardt, 304 U.S. 405 (1938)). And in First National

Bank, the Court reaffirmed this “fair share” idea by hold-

ing that States may, through their tax laws, “charg[e] tax-

exempt obligations and interest their fair share of related

expenses or burdens.” 470 U.S. at 593 (footnote

omitted ) .*°

Accordingly, taxpayers’ attempts to shelter income by

acquiring tax exempt securities as liabilities have been

rebuffed by the Court. In First National Bank, the Court

upheld a Georgia tax based on banks’ net worth which

permitted only the deduction of the pro rata share of

tax-exempt securities that represented assets. If a full

tax exemption were allowed for all federal securities, the

Court found, banks could shelter otherwise taxable assets

and avoid their fair share of the tax burden by acquiring

federal securities as liabilities. See id. at 596-97.

The First National Bank decision thus reaffirmed the

“fair share” theme that had appeared in prior decisions

involving efforts to obtain extra tax benefits through the

borrowing of money to purchase tax-exempt securities.

10 Cf. United States v. Atlas Life Insurance Co., 381 U.S. 233, 251

(1965) (“The doctrine of intergovernmental immunity does not re-

quire such a [tax] benefit to be conferred on the ownership of

municipal bonds.”) ; Helvering v. Gerhardt, 304 U.S. at 421 (collect-

ing cases in which “[t]he fact that the expenses of the state gov-

ernment might be lessened if all those who deal with it were tax

exempt was not thought to be an adequate basis for tax immunity’’).

23

See Atlas Life, 381 U.S. at 247; Denman v. Slayton, 282

U.S. 514 (1931). The First National Bank Court also

clarified that it had adopted the dissenting view of Justice

Stone in Missouri v. Gehner, 281 U.S. 313 (1930). See

470 U.S. at 591. In Gehner, Justice Stone stated that

“(t]he immunity of government bonds from taxation does

not carry with it immunity from liability for debts.” 21

U.S. at 323 (Stone, J., joined by Holmes and Brandeis,

JJ., dissenting ) (citation omitted).

This case involves a similar effort to reap a second tax

advantage from government securities, and thereby to

avoid paying a fair share of taxes on income from a

private credit arrangement. Cf. Union Planters Nat'l

Bank of Memphis v. United States, 426 F.2d 115, 116

(6th Cir.) (if income on repos involving municipal bonds

were not taxable, taxpayers “would be able to ~ joy the

benefit of the double tax advantage which Cvwugress in-

tended to prevent”), cert. denied, 400 U.S. 827 (1970).

Here, not only does the original owner of the government

securities continue to receive a tax exemption for interest

paid on the government instrument during the term of

the repurchase agreement, but the respondent also seeks

to claim a tax exemption for the interest he receives from

the holder of the government securities for the use of his

money during the repurchase term.

In sum, the notion that intergovernmental tax immunity

can be used to obtain double tax benefits by incurring

liabilities to obtain tax-exempt securities has been soundly

rejected. See, e.g., First Natl Bank, 470 U.S. at 596.

In legal and economic effect, it makes no difference that

in this case the interest Nebraska seeks to tax is paid not

on a loan taken out to buy government securities, but on

a loan taken out to increase cash flow after buying tax

exempt government securities (for which those securities

are used as collateral). See Union Planters, 426 F.2d at

116 (tax exemption for repo income would circumvent

Congress’ purpose of preventing double tax benefit in

IRC § 265(2)).

24

C. Principles Of Intergovernmental Tax Immunity Re-

quire That The Federal Tax Treatment Of Repur-

chase Income Involving Municipal Bonds Be Ana-

lyzed In The Same Manner As State Tax Treatment

Of Repurchase Income Involving Federal Obligations

Constitutional principles of intergovernmental tax im-

munity work not only to protect the instrumentalities of

the federal government from state and local taxation, but

also to protect state and local government instrumentali-

ties from federal taxation. See, e.g., Educational Films

Corp. v. Ward, 282 U.S. 379, 392 (1931) (“the purpose

{of intergovernmental tax immunity] is the preservation:

to each government, within its own sphere, of the free-

dom to carry on those affairs committed to it by the Con-

stitution, without undue interference by the other”) (col-

lecting cases).

Although the scope of the intergovernmental tax im-

munity afforded state and local governments is nct always

identical to that afforded the federal government, see,

e.g., McCulloch, 17 U.S. (4 Wheat.) at 435-36, the

Court has noted that “federal and state tax immunity

cases have always shared the identical methodology for

determining whether a tax is ‘on’ a government, and...

this identity has persisted even though the methodology for

both federal and state immunities has changed as inter-

governmental tax immunity shifted into the modern era.”

South Carolina v. Baker, 485 U.S. at 518 n.11. See also

Plummer, 178 U.S. at 117 (“[t]he reasoning upon which

these two lines of decision proceed is the same”).

Therefore, the question of whether the income on a

repurchase agreement involving government securities is

too attenuated from the exempt security itself to warrant

tax immunity is a question which should be answered in

exactly the same manner for the federal taxation of re-

purchase income involving municipal bonds, as for the

State taxation of repurchase income involving federal se-

curities. Cf. First Nat'l Bank, 470 U.S. at 591 (applying

25

doctrine set forth in a case involving the federal taxation

of municipal bonds to question involving state taxation

of federal obligations) (citing Denman v. Slayton, 282

U.S. 514 (1931)); Dravo Contracting, 302 U.S. at 157

(“While the Metcalf Case was one of a federal tax, the

reasoning and the practical criterion it adopts are clearly

applicable to the case of a state tax upon earnings under

a contract with the federal government.” ).

Federal appellate courts considering the question of the

federal taxation of income from repurchase agreements

involving municipal bonds have consistently held that such

income is taxable, despite the exemption granted to mu-

nicipal bond interest in the Internal Revenue Code. See,

e.g., Union Planters, 426 F.2d at 118; American Nat'l

Bank of Austin v. United States, 421 F.2d 442 (Sth

Cir.), cert. denied, 400 U.S. 819 (1970); Stigum, The

Repo and Reverse Markets at 334 & n.2 (collecting

cases). In so holding, these federal courts have used rea-

soning that closely parallels that used by state courts

holding that repurchase income is taxable. See, e.g.,

American Nat'l Bank of Austin, 421 F.2d at 452 (“In

short, taxpayer was in effect a lender secured by collateral

in its possession. Under these circumstances, we would

be blinding ourselves to reality if we did not see quite

clearly that taxpayer’s role here was that of a lending

institution . . . .”); Union Planters, 426 F.2d at 118

(repos “will be regarded as secured loans for federal in-

come tax purposes”). See also Stigum, The Repo and

Reverse Markets at 334 (“In the cases that the [federal]

government won, the courts treated the [municipal bond]

repos in question as collateralized loans rather than as

purchases and sales of securities. The focus of the courts

in those cases was on the economic substance of the repo

transactions.” ).

If the Court prohibits Nebraska from taxing respond-

ent’s repo income, it will inevitably call into question the

federal government’s ability to tax repo income involving

municipal bonds, upheld in the foregoing cases. Equality

* Counsel of Record for the

Amici Curiae

558)

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