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

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## Record

- **Collection:** Supreme Court brief
- **Document type:** Amicus Curiae Brief
- **Published:** January 1, 1994
- **Citation:** 513 U.S. 123

## Text

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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AND NATIONAL GOVERNORS’ ASSOCIATION
AS AMICI CURIAE IN SUPPORT OF PETITIONER

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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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.
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be

6

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385013_0474%3A09. Public record. Not legal advice.