Amicus Curiae Brief — NACCO Industries, Inc. v. Tracy

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No. 97-868 Oy

Jn the Supreme Court of the United States

OCTOBER TERM, 1997

NACCO INpbusTRIES, INC., PETITIONER

ROGER W. Tracy, On1I0 TAX COMMISSIONER

ON PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF OHIO

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING PETITIONER

SETH P. WAXMAN

Solicitor General

LORETTA C. ARGRETT

Assistant Attorney General

LAWRENCE G. WALLACE

Deputy Solicitor General

KENT L. JONES

Assistant to the Solicitor

General

ERNEST J. BROWN

DAVID ENGLISH CARMACK

Attorneys

Department of Justice

Washington, D.C. 20530-0001

(202) 514-2217

QUESTION PRESENTED

Whether Ohio impermissibly discriminates against

holders of federal obligations by requiring gains from

the sales of United States bonds to be included in

state taxable income while excluding from tax gains

from sales of Ohio state and local bonds.

(I)

TABLE OF CONTENTS

Page

Interest of the United States ..............cccccsccssecseseesseeeees l

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TABLE OF AUTHORITIES

Cases:

City of Chicago v. Environmental Defense Fund,

So ene ME A IE wins tasdsiniatevvasvpeideintakinnienenscieiinceeie 5

Doneski v. Comptroller, 605 A.2d 649 (Md. Ct.

Spec. App. 1992), cert. denied, 506 U.S. 1054

FE cichccaibissatticteyssenspcerditetuasanhthnmcaaventicnapieeninnqeiucsineiress ll

Memphis Bank & Trust Co. v. Garner, 459 U.S.

ST a sccdiliniattibiinbcbiaaicennetidniiintnidevvivnieiaseevententas 6, 7

Moses Lake Homes, Inc. v. Grant County,

Be As PIN EED shtssecascsovineswesnercnndbestseserneseoseseces 6

Nebraska Dep't of Revenue v. Loewenstein, 513

es BE IED dicctb te cebinsansebuitldnntninoncedsenssdutveideasrens 8

New Jersey Realty Title Ins. Co. v. Division of

Tax Appeals, 338 U.S. 665 (1950) .............cseeeeeeeee 6

Phillips Chem. Co. v. Dumas Indep. Sch. Dist.,

SE rs EEE CRIED i dicincnccnseescenctsnsancesovicsecasnseeseviwons 7

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

Be re tt CED Sc ccctetntniensecensexsecnnennbeeevensndsngene 8

Schuylkill Trust Co. v. Pennsylvania, 296 U.S. 113

III cl iia nin ca das baanaatesdninadbentninbnenbenewnsinsniones 6

Willcuts v. Bunn, 282 U.S. 216 (1931) ................... 7

Constitution and statutes:

U.S. Const. Art. VI, Cl. 2 (Supremacy Clause) ........ 5

Internal Revenue Code (26 U.S.C.):

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(II)

Statutes—Continued: Page

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Ohio Rev. Code Ann. § 5733.04(1)(6) (Anderson

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Jn the Supreme Court of the United States

OCTOBER TERM, 1997

NACCO INbusTRIES, INC., PETITIONER

Vv.

ROGER W. TRACY, OHIO TAX COMMISSIONER

ON PETITION FOR A WRIT OF CERTIORARI

TO THE SUPREME COURT OF OHIO

BRIEF FOR THE UNITED STATES

AS AMICUS CURIAE SUPPORTING PETITIONER

INTEREST OF THE UNITED STATES

Substantial amounts of United States bonds are

owned by taxpayers who reside in Ohio and who are

subject to the tax laws of that State. In this case, the

Ohio Supreme Court upheld the imposition of a state

tax on gains realized from sales of United States

bonds even though the tax is not imposed on gains

realized from sales of Ohio state and local bonds. This

discrimination in treatment between holders of fed-

eral obligations and holders of state obligations vio-

lates the intergovernmental immunity doctrine of the

Constitution. The United States markets its secu-

rities throughout the Nation and has an important

interest in assuring that the holders of its obligations

are not subject to discriminatory state taxation.

(1)

STATEMENT

1. In 1982, petitioner paid $6,100,003 to purchase a

fifteen-year U.S. Treasury Bond with a principal

amount of $8,000,000 (Pet. App. la). Because this bond

was backed by the full faith and credit of the United

States government, petitioner was certain to realize a

gain of $1,899,997 if the bond were held to maturity.’

Petitioner could have incurred a loss from ownership

of the bond only if interest rates increased after the

date the bond was acquired and the bond was sold

before it reached maturity.

Petitioner sold the bond in 1989 for $7,694,071. The

sales proceeds included (i) a return of petitioner’s in-

vestment of $6,100,003, (ii) accrued but unpaid interest

on the bond in the amount of $126,575 and (iii) a real-

ized gain from ownership of the bond in the amount of

$1,467,493 (Pet. App. 1a).

2. Ohio imposes a corporate franchise tax that is

computed on both a net worth and net income basis.

Corporations are to pay “whichever produces the

' The discount that petitioner paid from the face value of

the bond was not “original issue discount” of the type that is

treated as imputed interest income under the Internal Revenue

Code. See 26 U.S.C. 1271-1275. The discount instead resulted

from the operation of ordinary economic principles on the fact

that market interest rates increased between the time that the

bond was first issued and the time that it was purchased by

petitioner. The difference between the purchase price of the

bond and the price at which it was sold would therefore ordi-

narily be treated as a capital gain under the Internal Revenue

Code. See 26 U.S.C. 1001(a). The fact that the gain was cer-

tain to occur if the bond had been held to maturity, however,

makes the enhanced value obtainable from holding the bond to

maturity analogous to additional interest payments on the

bond.

greater tax” (Pet. App. 2a). In calculating the tax due

on the net income basis, “[t]he initial base * * * is

federal taxable income” (ibid.). From that initial

base, corporations are permitted to “[aldd any loss or

deduct any gain resulting from the sale, exchange, or

other disposition” of Ohio state and local bonds (ibid.,

quoting Ohio Rev. Code Ann. § 5733.04(1)(6) (Anderson

1996)). Ohio law does not, however, permit a similar

adjustment for the gains included in federal taxable

income that are attributable to the sale, exchange or

other disposition of United States bonds. As the Ohio

Supreme Court recognized in this case, the result is

that the “gain from the sale of an Ohio obligation is

exempt from the Ohio franchise tax, while gain from

the sale of a federal obligation is not” (Pet. App. 2a).

3. In reporting taxable income on its Ohio return

for 1990, petitioner did not include the $1,467,493 gain

that it realized that year from the sale of the federal

bond. Petitioner asserted that tie state tax statute

violated the constitutional intergovernmental immu-

nity doctrine, and 31 U.S.C. 3124(a), by discrimina-

torily imposing a tax on the gain from the sale of

federal bonds while exempting from tax any similar

gain on state bonds.* The Tax Commissioner of Ohio

2 31 U.S.C. 3124(a) provides that:

Stocks and obligations of the United States Government

are exempt from taxation by a State or political subdivision

of a State. The exemption applies to each form of taxation

that would require the obligation, the interest on the

obligation, or both, to be considered in computing a tax,

except—

(1) a nondiscriminatory franchise tax or another non-

property tax instead of a franchise tax, imposed on a

corporation; and

rejected petitioner’s claim. The Ohio Board of Tax

Appeals affirmed, noting that it lacked jurisdiction to

consider any constitutional objections to the state tax

(Pet. App. 12a-20a).

4. The Ohio Supreme Court affirmed (Pet. App. la-

lla). The court first rejected the contention that the

state tax violates 31 U.S.C. 3124(a). That statute gen-

erally prohibits state taxation “that would require

the [federal] obligation, the interest on the [federal]

obligation, or both, to be considered in computing a

tax” (81 U.S.C. 3124(a)). The court concluded that

this statute does not apply to the Ohio tax because the

value of the federal bonds did not have to be considered

in computing the tax (Pet. App. 5a). The court

reasoned that the gain taxed by Ohio is determined by

comparing the purchase and sale prices of petitioner’s

private transactions, not by considering the “obliga-

tion” of the United States under the bonds (ibid.).

In concluding that 31 U.S.C. 3124(a) is inapplicable

to the challenged state tax, the court also relied

on the difference in the language of that statute and

31 U.S.C. 3124(b). The court noted that 31 U.S.C.

3124(a)—which precludes various types of state taxa-

tion of federal obligations—makes no explicit refer-

ence to gains from transactions in federal obligations;

by contrast, 31 U.S.C. 3124(b)—which provides for

federal taxation of federal obligations—contains an

explicit reference to gains from transactions in such

obligations. The court reasoned that Congress acted

“intentionally and purposely” by including the refer-

ence to gains from such transactions in one subsec-

tion while omitting it in the other (Pet. App. 4a,

(2) an estate or inheritance tax.

quoting City of Chicago v. Environmental Defense

Fund, 511 U.S. 328, 388 (1994)). The court concluded

that, if Congress had “intended Section 3124(a)

immunity to extend to gains from the sale of federal

obligations, it would have expressed that intent in the

statute” (Pet. App. 5a).

The Ohio Supreme Court further held that the Ohio

statute does not unconstitutionally discriminate

against the holders of federal obligations (Pet. App.

6a-lla). The court stated that a state tax that dis-

criminates against the holders of federal obligations

does not violate the Supremacy Clause if Congress

has authorized the discrimination (Pet. App. 9a). The

court held that by expressly precluding the States

from imposing taxes on the principal or interest

received from federal bonds under 31 U.S.C. 3124(a)—

and not expressly precluding state taxation of gains

realized from the sales of such bonds—Congress im-

plicitly authorized the States to discriminate in their

tax treatment of the latter (Pet. App. 9a).

The court further held that, even if it “must con-

sider whether the tax is discriminatory,” the Ohio

tax would be valid (Pet. App. 9a). The court noted that

an expert witness had testified at trial that “exclu-

sion of gain from the sale of state obligations but not

federal obligations would place federal obligations at

a disadvantage in the market” (id. at 10a). The court

stated, however, that the Ohio statute (by incorporat-

ing federal taxable income) permits losses, as well as

gains, from sales of federal bonds to be considered in

computing the state tax (ibid.). The court stressed

that the expert witness had not expressed “an opinion

on the relative marketability of the obligations when

accounting for both gains and losses from the sale of

federal obligations but not on state obligations”

(ibid.). The court stated that it was therefore “mere

conjecture or speculation” whether Ohio’s discrimi-

natory treatment of holders of federal obligations

affected “the relative marketability” of federal bonds

(:bid.). The court held that such “speculation” could

not support a conclusion that the Ohio statute

violates the Constitution (id. at 11a).

ARGUMENT

1. The Ohio franchise tax unconstitutionally dis-

criminates against the holders of federal obligations.*

“A state tax that imposes a greater burden on holders

of federal property than on holders of similar state

property impermissibly discriminates against federal

obligations.” Memphis Bank & Trust Co. v. Garner,

459 U.S. 392, 397 (1983). See also Moses Lake Homes,

Inc. v. Grant County, 365 U.S. 744 (1961); Schuylkill

Trust Co. v. Pennsylvania, 296 U.S. 113 (1935). By

3 The existence of “discrimination” in the state tax scheme

is a required element for both the constitutional and statutory

theories urged by petitioner. A state tax that falls within the

scope of 31 U.S.C. 3124(a) is not invalid if it is “a nondis-

criminatory franchise tax * * * imposed on a corporation”

(ibid.). In cases in which the statutory and constitutional prohi-

bitions both turn on the existence of discrimination, this Court

has focussed on the extensive constitutional precedent that

elaborates the nondiscrimination requirement. See, e.g., Mem-

phis Bank & Trust Co. v. Garner, 459 U.S. 392, 397 (1983);

New Jersey Reaity Title Ins. Co. v. Division of Tax Appeals,

338 U.S. 665, 672 (1950). The Court’s decisions “have treated

{the statute] as principally a restatement of the constitutional

rule.” Memphis Bank & Trust Co. v. Garner, 459 U.S. at 397.

We therefore address only the constitutional issue in this brief.

4 “(T}t still remains true, as it has from the time of

M’Culloch v. Maryland, 4 Wheat. 316, that a state tax may not

discriminate against the Government or those with whom it

NE ee eee ee Rae Re Te ES REE Sige Re a

taxing gains realized from sales of federal obligations

but exempting similar gains realized from sales of

state obligations, the Ohio tax “imposes a greater

burden on holders of federal property than on holders

of similar state property” and thus “impermissibly

discriminates” against federal obligations (Memphis

Bank & Trust Co. v. Garner, 459 U.S. at 397).

a. The Ohio Supreme Court erred in concluding

that, to establish the existence of discriminatory

state taxation, the taxpayer has the burden of show-

ing that the tax actually hinders the marketing of

federal securities (Pet. App. 10a). The decisions of

this Court do not support that proposition.

The Ohio Supreme Court noted that, in Willcuwts v.

Bunn, 282 U.S. 216 (1931), this Court stated that a

tax on gains from the sale of government bonds does

not necessarily disadvantage the marketing of such

bonds if “there is also a deduction for losses on sales”

(Pet. App. 8a, quoting 282 U.S. at 231). In upholding

application of the federal income tax to gains realized

from sales of state bonds in Willcuts, the Court

rejected the assertion that such a tax unconstitution-

ally interfered with “a function of government” (Pet.

App. lla). The Court emphasized, however, that

the federal tax involved in Willcuts was “non-

discriminatory” because it applied equally to gains

from sales of federal and state bonds. 282 U.S. at 227.

In upholding such nondiscriminatory taxation, the

Court did not suggest in Willcuts that the victims of

discriminatory taxation would be required to estab-

lish that the tax adversely “affects a function of

deals.” Phillips Chemical Co. v. Dumas Independent School

District, 361 U.S. 376, 387 (1960).

government” (Pet. App. lla), as the court erroneously

held in this case.°

The Ohio Supreme Court also erred in relying (Pet.

App. 10a) on Rockford Life Insurance Co. v. Illinois

Department of Revenue, 482 U.S. 182 (1987). In that

case, this Court upheld application of a nondiscrimi-

natory state property tax to bonds that were issued

by private institutions and guaranteed by the United

States. The Court stated that the possibility that the

United States would have to honor its guarantee was

too speculative to warrant the conclusion that such

bonds were “obligations” of the United States to

which constitutional immunity attaches. /d. at 190.

That holding does not support the conclusion of the

court below that the evidence in this case is insuffi-

cient “speculation” (Pet. App. 10a) to support a find-

ing of discrimination.

b. Indeed, the Ohio Supreme Court acknowledged

that the evidence in this case establishes that the

state tax on gains realized on federal bonds, and its

®° The question whether a state tax “discriminates against

federal obligations” (Nebraska Dep't of Revenue v. Loewenstein,

513 U.S. 123, 135 (1994)) is separate from the question whether

the state tax violates “the intergovernmental tax immunity

doctrine” by “taxing federal obligations in a manner which has

an adverse effect on the United States’ borrowing ability” (id.

at 136). In Loewenstein, the Court rejected a claim of discrimi-

nation because the State treated income derived from state and

local obligations no differently than it treated income derived

from federal obligations. Jd. at 135-136. The Court then re-

jected the further claim that the state tax unconstitutionally

interfered with “the borrowing power” of the United States

because there was “no evidence in the record that the taxation

at issue will impair the market in federal securities or other-

wise impair the borrowing ability of the Federal Government.”

Id. at 137.

exemption for gains realized on state bonds, discrimi-

nates against holders of federal bonds (Pet. App. 10a).

Nothing about that evidence involves “mere conjec-

ture or speculation” (ibid.). What is merely “conjec-

ture or speculation,” however, is the state court’s

suggestion that a compensating benefit to the holders

of federal bonds might occur because state law per-

mits losses on sales of federal bonds to be recognized

under the state tax but does not allow losses on sales

of state bonds to be so recognized.

In the first place, there is no authority for the

court’s proposition that an established discrimination

against a holder of federal property may be permitted

because of the speculative possibility that a compen-

sating advantage might exist elsewhere in the state

tax scheme in some other year or for some other

holder of federal property. Such an unmanageable

proposition has never been adopted by this Court.

Indeed, as petitioner notes (Pet. 19-20), similar propo-

sitions have been rejected by the Court in analogous

constitutional contexts involving state taxation.

Moreover, the Ohio Supreme Court erred in assum-

ing that a state taxpayer would, by incorporating

federal taxable income under the state statute, obtain

a compensating advantage from any “losses” realized

from sales of federal bonds. Net losses from the sales

of government bonds would not be a component of

federal taxable income for corporate taxpayers be-

cause the Internal Revenue Code specifies that, “[{i]n

the case of a corporation, losses from sales or ex-

changes of capital assets shall be allowed only to the

extent of gains from such sales or exchanges” (26

come that is incorporated for state tax purposes

under Ohio law thus may include a net gain from

transactions in capital assets but, under 26 U.S.C.

1211(a), it will not include a net loss. The Ohio Su-

preme Court thus erred in concluding that a taxpayer

would, by incorporating federal taxable income under

the state statute, obtain an advantage from net losses

that could offset the disadvantage incurred by dis-

criminatory state taxation of net gains on the sales of

federal bonds.

Both for corporate and individual taxpayers (see

note 6, supra), the state tax discriminates directly

against the holders of federal bonds by requiring

inclusion of gains on sales of federal bonds while

excluding gains on state bonds. There is no compen-

sating advantage “when accounting for both gains and

losses” (Pet. App. 10a). Even if it were conceptually

possible for a State to justify discriminatory treat-

ment of federal obligations by some compensating

advantage otherwise provided under state law—a

conclusion that this Court has never reached—the

State has not sustained its burden of doing so on the

record of this case.’

6 Losses from such transactions for corporations may be

carried back three years and carried forward five years to be

offset against gains in other periods. 26 U.S.C. 1212(a). A net

loss is not reflected in federal taxable income, however, for any

period. By contrast, individuals may report a net loss from

such transactions, but only up to the amount of $3000 in any

year. 26 U.S.C. 1211(b).

7 For the reasons summarized by petitioner (Pet. 14-15), the

Ohio Supreme Court plainly erred in suggesting (Pet. App. 9a)

that, in enacting 31 U.S.C. 3124(a), Congress implicitly author-

2. The decision of the Ohio Supreme Court in this

case is of broad recurring importance. Other States

either have imposed, or could impose, similar tax

schemes that advantage their own obligations by

disadvantaging those of the United States. See Pet.

20. In holding a similar state tax provision uncon-

stitutional, the Maryland Court of Special Appeals

recognized that taxing gains from federal obligations

while exempting gains from state obligations “dimin-

ish[es] the investment attractiveness of the United

States obligations in favor of state obligations.”

Doneski v. Comptroller, 605 A.2d 649, 653 (1992), cert.

denied, 506 U.S. 1054 (1993). A state tax that dis-

criminates against the holders of federal bonds

interferes with the extraordinarily important federal

function of marketing trillions of dollars of United

States obligations. Review by this Court is war-

ranted to ensure that States are not permitted to

favor their own obligations by discriminating against

those of the National government.

ized discriminatory state taxation of gains from sales of federal

securities.

CONCLUSION

The petition for a writ of certiorari should be

granted.

Respectfully submitted.