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

No.97-868 (5 ) DEC 24 997

SS

IN THE

Supreme Court of the United States

OCTOBER TERM, 1997

NACCO INDUSTRIES, INC.,

Petitioner,

Vv.

RoGER W. Tracy, TAX COMMISSIONER OF OHIO,

Respondent.

On Petition for a Writ of Certiorari to the

Supreme Court of Ohio

BRIEF OF THE BOND MARKET ASSOCIATION

A’ AMICUS CURIAE IN SUPPORT OF PETITIONER

PAUL SALTZMAN CHARLES F.. LETTOW

SARAH M. STARKWEATHER (Counsel of Record)

THE BOND MARKET GIOVANNI P. PREZIOSO

ASSOCIATION ONNIG H. DOMBALAGIAN

40 Broad Street ABBY F’. RUDZIN

New York, NY 10004-2373 CLEARY, GOTTLIEB, STEEN

ERIKA W. NIJENHUIS & HAMILTON ©

CLEARY, GOTTLIEB, STEEN 2000 Pennsylvania Ave., N.W.

& HAMILTON Washington, D.C. 20006-1801

One Liberty Plaza (202) 974-1500

New York, NY 10006-1470 Counsel for

The Bond Market Association

December 24, 1997 as Amicus Curiae

WILSON - EPes PRINTING Co., INC. - 789-0096 - WASHINGTON, D.C. 20001

at ohashe et AO en

QUESTIONS PRESENTED *

Ohio’s corporate franchise tax taxes gains on the sale

of United States Treasury Bonds and other federal obliga-

tions, but excludes gains on the sale of comparable state

obligations. This case presents the following questions:

1. Whether Ohio’s discriminatory tax violates 31

U.S.C. § 3124(a), which bars “each form of taxation

that would require the [United States] obligation, the in-

terest on the obligation, or both, to be considered in com-

puting atax....”

2. Whether Ohio’s tax impermissibly discriminates

against holders of federal obligations in violation of the

intergovernmental tax immunity doctrine under the Su-

premacy Clause of the United States Constitution.

* These questions are set out as stated in the petition.

(i)

TABLE OF CONTENTS

Page

QUESTIONS PRESENTED qn. .-ecnseccssncemsesesoessnins 1

pe Gc gS ~ , SRAM Ne EO iv

INTEREST OF THE AMICUS CURIAE ...................... 1

THE OHIO SUPREME COURT'S DECISION .............. 3

REASONS FOR GRANTING THE WRIT .................... 4

I. OHIO’S DISCRIMINATORY TAX ON GAIN

FROM DISPOSITION OF TREASURY OBLI-

GATIONS IMPERMISSIBLY DIMINISHES

THE INVESTMENT ATTRACTIVENESS OF

OBLIGATIONS ISSUED BY THE UNITED

ck ET TRATES CN MABE 2, creo EGR Manes mp 6

II, CERTIORARI SHOULD BE GRANTED TO

RESOLVE THE CONFLICT BETWEEN THE

DECISION OF THE OHIO SUPREME COURT

TO UPHOLD THIS TAX AND DECISIONS BY

OTHER STATE COURTS INVALIDATING

EE I i lc ao ec 9

III. CERTIORARI SHOULD BE GRANTED TO

CORRECT THE OHIO SUPREME COURT'S

MISINTERPRETATION OF SECTION 3124

AND MISAPPLICATION OF THIS COURT’S

PRECEDENTS CONSTRUING THAT STAT-

Ck ERS oS RRO ES RRs SOE Ss re se ARE ake er oN OO 12

IV. THE OHIO SUPREME COURT’S DECISION

CONTRAVENES THE INTERGOVERNMEN-

TAL TAX IMMUNITY DOCTRINE OF FED-

ERAL CONSTITUTIONAL LAW ........0 0... 16

PRENTICE EER oO es RoE EN 19

|

: 1

iv |

TABLE OF AUTHORITIES

Cases Page

American Bank & Trust Co. v. Dallas County, 463

Tee NE CRD cpccnre cence oecenanees 5, 13, 16

Ciyt of Philadelphia v. New Jersey, 437 U.S. 617

CRIN ig ecancsbeeskcntesabeiuchbecasuktatsipade ausskousnonsneineson 18

Commonwealth v. Curtis Publishing Co., 363 Pa.

299, 69 A.2d 410 (1949) ._............. 11

Doneski v. Comptroller of the Treasury, 605 A2d

649 (Md. Ct. Spec. App. 1992), cert. denied, 506

io Be Rt Es en 4,9, 15

Field v. Mans, 516 U.S. 59 (1996) ..........-..........-....... 15

Forbes, Inc. v. Department of Finance, 487 N.E.2d

251 (N.Y. 1985), cert. denied, 475 U.S. 1109

2): EMER REE SMR Re CORRE EET SSNS. ENSUE A Be ts oS PRE 4,10

Gozlon-Peretz v. United States, 498 U.S. 395

CGS Y otk re 14

Lunding v. Tax Appeals Tribunal of the State of

New York, No. 96-1462 (argued November 5,

BOE vnc ccceatnsciensiuad aaa aac aiieenas sanaad gets 18

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

a ae 5, 16, 18

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

TE IIE cisssd tesiecis cc eened cecndensicinaiapeaecomauaal 5, 12, 18, 15, 16

Missouri ex rel. Missouri Ins. Co. v. Gehner, 281

Ce: ee OD endorsed cele. A 12

Nebraska Dep’t of Revenue v. Loewenstein, 513

TM 19 TA nn. eee ae 13, 14, 16, 18

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

Appeals, 388 U.S. 665 (19650) ..............2................. 12

Pike v. Bruce Church, Inc., 397 U.S. 187 (1970)... 18

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

a aphinann 15, 16, 18

Smith v. Davis, 323 U.S. 111 (1944) ..................... passim |

Toomer v. Witsell, 334 U.S. 385 (1948) .............. 18

United States v. County of Fresno, 429 U.S. 452

CIEE Sociicecrnd icc a cinculghllscdsedaiecoupieiebedaaiasiaicssaiteined 6, 17, 18

Willeuts v. Bunn, 282 U.S. 216 (1981) ~................... 17, 18

Constitutional Provisions

Ts SE, AG Be a Bt i ere 18

pe RE me SSS Reem ntoni mncrerr coe” 18

—— ee

v

TABLE OF AUTHORITIES—Continued

Page

fp Na a ay 2 OY Bae a ae Oe ae eae 18

Ohio Const., art. VIII, § 2K (D) (4) ......... <oinaiteiuntuba 8

Statutes and Regulations

Federal

Act of Feb. 25, 1862, ch. 33, 12 Stat. 345 00. 15

Government Securities Act of 1986, Pub. L. No.

SAT ta: Se Gs TE be 7

Government Securities Act Amendments of 1993,

Pub. L. No. 103-202, 107 Stat. 2344 7

Pub. L. 86-346, § 105(a), 73 Stat.621......0 12, 13

Pub. L. No. 97-258, § 3124, 96 Stat. 877,945 15

i Sls Te RIN Gi het ioe alain hs passim

I7 C.F ae pe Gee-tee C1007) 7

2P RAs es Oe CE eric 7

State

By. Rev. Stat. 141.010 010) (a) |... 12

Mich. Comp. Laws § 206.80 .......................---..0:.-.-..-.... 11

Ohio Rev. Code Ann. § 5709.76(D) _............ 3

Ohio Rev. Code Ann. § 5733.04(I) 8

Ohio Rev. Code Ann. § 5733.06 ............... 3

Co, ee, Se Oe A 12

Other Authorities

Department of the Treasury, Securities and Exch.

Comm’n, and Board of Governors of the Fed.

Reserve Sys., Joint Report on the Government

Securities Market (Jan. 1992) .......... pete A

Financial Mgmt. Serv., Department of the Treas-

ury, Treasury Bulletin (Sept. 1997)... 6

Pennsylvania Dep’t of Revenue Tax Update No. 16

RUNNIN ROME fd ee ey 10, 11

S. Rep. No. 86-909 (1959), reprinted in 1959

Lik See sk 3 Ome .. NSmuRaMleeNeinta dn aman taiamtt. 13

IN THE

Supreme Court of the United States

OCTOBER TERM, 1997

No. 97-868

NACCO InpbustrIEgs, INc.,

. Petitioner,

ROGER W. Tracy, TAX COMMISSIONER OF OHIo,

Respondent.

On Petition for a Writ of Certiorari to the

Supreme Court of Ohio

BRIEF OF THE BOND MARKET ASSOCIATION

AS AMICUS CURIAE IN SUPPORT OF PETITIONER

INTEREST OF THE AMICUS CURIAE

The Bond Market Association submits this brief as

amicus curiae with the consent of the parties as specified

in this Court’s Rule 37.2(a).1 The Bond Market Asso-

ciation represents securities firms and banks that under-

write, trade, and sell debt securities in the U.S. and inter-

national markets. Amicus’ members deal in a wide variety

of public and private debt securities, including state and

municipal obligations as well as those issued by the De-

partment of the Treasury and other entities of the federal

government. All of the primary dealers in Treasury obli-

gations, as recognized by the Federal Reserve Bank of

New York, are members of the Association, along with

1 The written consents of the parties are on file with the Clerk

of this Court.

2

other government securities dealers. From its inception

in 1976,” the Association has addressed significant govern-

ment securities issues that confront the industry, fostered

sound credit, business, and trading practices for partici-

pants in the bond markets, and undertaken initiatives to

improve market efficiency. Much of its work regarding

federal obligations involves proceedings or actions taken

by the Department of the Treasury’s Bureau of the Public

Debt.

The taxation of both state and federal obligations is of

interest to amicus insofar as it bears on the effective func-

tioning of markets for those debt obligations. In general,

the markets are more efficient with evenhanded, predict-

able tax treatment of earnings and proceeds from debt

securities. This is true for interest income, and it is

equally true for gains and losses on dispositions of such

securities, whether upon redemption at maturity or upon

sale in the secondary market. In this latter respect, a

viable, efficient secondary market in debt obligations pro-

vides strong support for the primary (new issues) market

in such securities. See Department of the Treasury, Securi-

ties and Exch. Comm’n, and Board of Governors of the

Fed. Reserve Sys., Joint Report on the Government Securi-

ties Market (Jan. 1992) (hereinafter “Joint Report’).

Investors are more likely to purchase debt obligations if

they have assurance that they need not necessarily hold

the obligations to maturity but rather may sell them in a

secondary market under competitive, efficient conditions.

This case addresses a franchise tax that is not even-

handed and that introduces a tax-based disadvantage into

the secondary marketplace for federal debt (Treasury)

obligations. Because of the importance of the secondary

market in Treasury securities to amicus and its members,

this brief is submitted to assist the Court in its evaluation

of the petition for certiorari.

2 Amicus was previously named the Public Securities Association.

ee

3

THE OHIO SUPREME COURT’S DECISION

This case deals with NACCO’s investment in a bond

issued by the U.S. Treasury, and the gain realized on the

sale of that bond in the secondary market. Pet. 4. Under

Ohio law, a corporation calculates its net income by in-

cluding any net gains from the sale of federal obligations

but not such gains from the sale of Ohio securities. See

Pet. 4-5 (discussing Ohio Rev. Code Ann. §§ 5709.76(D)

and 5733.04(I)). The Ohio Department of Taxation as-

sessed a corporate franchise tax* on the gain from the

sale of the Treasury bond, and NACCO appealed, first

to the Ohio Board of Tax Appeals and then to the Ohio

Supreme Court. Pet. 5-7.

The Ohio Supreme Court upheld the assessment, reject-

ing NACCO’s claims that the taxation of gain on the

Treasury bond was barred by 31 U.S.C. § 3124 and the

intergovernmental tax immunity doctrine arising from the

United States Constitution. Pet. App. la, lla. As to

Section 3124, the Ohio Supreme Court acknowledged that

the statute operated to exempt federal obligations from

state taxation,* but the Court held that Section 3124 did

not apply to the taxation of a transaction between two

private parties in which a Treasury bond was exchanged.

Pet. App. 5a. The Ohio Supreme Court also concluded

8’ Under Ohio Rev. Code Ann. § 5733.06, corporations pay a fran-

chise tax calculated either on a net worth or a net income basis,

whichever yields the greater liability. In NACCO’s case, the income

method resulted in a larger tax payment.

*The text of 31 U.S.C. § 3124(a) provides:

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 non-

discriminatory franchise tax or another nonproperty tax in-

stead of a franchise tax, imposed on a corporation; and (2) an

estate or inheritance tax.

(Emphasis added.)

4

that the constitutional intergovernmental tax immunity

doctrine did not prohibit Ohio’s tax. Pet. App. 9a-lla.

Although Ohio did not contest that its tax scheme treated

gain from sales of federal and state obligations differently,

Pet. 7, the Ohio Supreme Court considered that there was

insufficient evidence that this “difference in treatment be-

tween state and federal obligations affect[ed] or impede[d]

a function of the federal government; in this case, the

marketability of federal obligations.” Pet. App. 10a.

REASONS FOR GRANTING THE WRIT

By taxing gains on the disposition of federal obligations

but not its own, Ohio “diminish[es] . . . the investment

attractiveness of obligations issued by the United States.”

Smith v. Davis, 323 U.S. 111, 117 (1944). Obligations

of the Treasury, which enable the U.S. government to

satisfy its borrowing needs, constitute the largest, safest

pool of debt instruments available to investors in the

world. The size and liquidity of the secondary market in |

Treasury obligations allow investors to adjust their hold- |

ings quickly and conveniently, making the obligations |

attractive to individual, institutional, and zovernmental in-

vestors worldwide. Discriminatory state taxes, such as the

Ohio corporate franchise tax at issue here, that burden

this secondary market “in the slightest degree,” id., are

barred both by the federal statute implementing the inter-

governmental tax immunity doctrine, 31 U.S.C. § 3124(a),

and by that constitutional doctrine itself.

The Ohio Supreme Court’s decision to uphold the Ohio

tax against statutory and constitutional challenges stands

alone in recent jurisprudence. The decision conflicts with

decisions by other state courts invalidating taxes that dis-

criminated against federal debt obligations, see Doneski

v. Comptroller of the Treasury, 605 A.2d 649 (Md. Ct.

Spec. App. 1992) (Maryland income tax), cert. denied,

506 U.S. 1054 (1993); Forbes, Inc. v. Department of

Finance, 487 N.E.2d 251 (N.Y. 1985) (New York City

corporation tax), cert. denied, 475 U.S. 1109 (1986),

ae Re eee TNE Re ae RE ee |

5

and stands in stark contrast to the tax scheme employed

by the great majority of states (with Ohio, Connecticut,

and Kansas in the small minority), which either equally

tax gains from dispositions of both federal and state obli-

gations, or tax gains from neither one, thus giving even-

handed treatment. Certiorari should be granted to resolve

the conflict in decisions between the Ohio Supreme Court

and the state courts which have disapproved a discrimina-

tory state tax law.

In holding that the federal intergovernmental tax im-

munity statute, 31 U.S.C. § 3124(a), does not pertain to

taxation of gains realized from transactions in the second-

ary market for Treasury obligations, the Ohio Supreme

Court ignored the fact that the statute by its own terms

“applies to each form of taxation [requiring] the [federal]

obligation . . . to be considered in computing a tax.” This

statute is “principally a restatement of the constitutional

rule” of intergovernmental tax immunity, Memphis Bank

& Trust Co. v. Garner, 459 U.S. 392, 397 (1983), and

“it “extends to every form of [state] taxation . . . [where

federal obligations] must be considered, directly or in-

directly, in the computation of the tax.’” American

Bank & Trust Co. v. Dallas County, 463 U.S. 855, 862

(1983) (quoting Rev. Stat. § 3701, 31 U.S.C. § 742,

the immediate predecessor of 31 U.S.C. § 3124(a)) (em-

phasis in original). By contrast, the Ohio Supreme Court

concluded that “the transaction subject to the tax does not

arise directly from the relationship between the taxpayer

and the federal government” but rather “from a contrac-

tual relationship between two private parties,” Pet. App.

lla, disregarding that it is the appreciation in market

value of a Treasury obligation that is being taxed. This

Court should grant certiorari to correct the Ohio Supreme

Court’s interpretation of Section 3124(a) contrary to this

Court’s precedent.

Decisions of this Court, beginning with McCulloch v.

Maryland, 4 Wheat (17 U.S.) 316 (1819), and continu-

6

ing to the present day, teach that the intergovernmental

tax immunity doctrine of federal constitutional law,

wholly apart from Section 3124(a), bars Ohio from im-

posing “a state tax . . . on those who deal with the Fed-

eral Government” when the tax “is [not] imposed equally

on... similarly situated constituents of the State.” United

States v. County of Fresno, 429 U.S. 452, 462 (1977).

Here Ohio’s tax laws impermissibly discriminate in favor

of its own state and municipal obligations, and certiorari

should be granted to uphold the important constitutional

interest.

I. OHIO’S DISCRIMINATORY TAX ON GAIN FROM

DISPOSITION OF TREASURY OBLIGATIONS IM-

PERMISSIBLY DIMINISHES THE INVESTMENT

ATTRACTIVENESS OF OBLIGATIONS ISSUED

BY THE UNITED STATES

By taxing gains on the disposition of federal debt obli-

gations, but not its own, Ohio burdens the secondary mar-

ket for federal obligations and thus impermissibly “dimin-

ish[es] . . . the investment attractiveness of obligations

issued by the United States.” Smith v. Davis, 323 US.

at 117.

By issuing Treasury obligations, the U.S. Government

secures credit necessary to carry on its functions. The

public debt of the United States, as of June 1997,

amounted to over $5.37 trillion, approximately $3.43

trillion of which represents marketable securities. See

Financial Mgmt. Serv., Department of the Treasury,

Treasury Bulletin at 18-19 (Sept. 1997). In 1996, the

Treasury auctioned over $2.4 trillion in marketable secu-

rities to the public, both to cover the budget deficit of

the United States and to finance maturing debt. Because

Treasury obligations are backed by the full faith and

credit of the U.S. Government, Treasury obligations con-

stitute the largest, safest pool of marketable debt instru-

ments available to investors in the world.

eee

7

The depth and liquidity of the secondary market for

Treasury obligations substantially enhance the attractive-

ness of the obligations and ensure that the Treasury may

offer them to the primary market at the best possible in-

terest rate, thus minimizing the Treasury’s cost of borrow- |

ing. The daily volume of secondary market transactions

in Treasury securities involving primary dealers averaged

approximately $204 billion in 1996. The high volume of

secondary market trading ensures that investors are able

to adjust their Treasury holdings quickly. To manage

the daily volume of trading in Treasury obligations, the

U.S. Treasury relies on a well-connected network of pri-

mary dealers, nonprimary dealers, and interdealer and

retail brokers who make competitive markets in Treasury

obligations. See Joint Report at A-9 to A-10. As a result

of the significant competition, secondary market dealers

often charge commissions of as little as 1/32 of one per-

centage point on transactions in Treasury obligations, thus

enabling investors to buy and sell Treasury securities at

fair market prices. Because of the high liquidity and price

efficiency of the secondary market, Treasury obligations

5In enacting the Government Securities Act of 1986, Pub. L.

No. 99-571, 100 Stat. 3208 (codified in scattered sections of 15

U.S.C.), and the Government Securities Act Amendments of 1993,

Pub. L. No. 103-202, 107 Stat. 2344 (codified in scattered sections |

of 15 U.S.C.), Congress recognized the critical importance of the |

efficiency and liquidity of the secondary market for Treasury securi- |

ties to the ability of the United States to obtain credit. The Acts, |

among other things, authorized the Department of the Treasury

to promulgate rules and regulations governing brokers and dealers

in government securities, see Government Securities Act of 1986,

title I; Pub. L. No. 99-571, 100 Stat. at 3208-22 (codified at 15

U.S.C. § 780-5 and in scattered sections of 15 U.S.C.); see also

Government Securities Act Amendments, § 102, Pub. L. No. 103-202,

107 Stat. at 2345, 15 U.S.C. § 780-5 (extending the Treasury’s rule-

making authority): 17 C.F.R. pts. 400-405 (1997), and to set

recordkeeping and reporting requirements for market participants

with large positions in particular Treasury issues, see Government

Securities Act Amendments of 1993, § 104, Pub. L. No. 103-202, 107

Stat. at 2346-48, 15 U.S.C. § 780-5(f); 17 C.F.R. pt. 420 (1997).

are considered the equivalent of cash for a number of

purposes and are widely held by individuals, pension

funds, financial institutions, insurance companies, and

other institutional investors, as well as foreign and domes-

tic governmental investors.

Ohio, together with other states that discriminatorily

tax capital gains on Treasury obligations, burdens the

secondary market for Treasury obligations without impos-

ing a like burden with respect to its own obligations. The

intergovernmental tax immunity doctrine and the federal

Statute implementing it, 31 U.S.C. § 3124(a), bar any

tax that discriminatorily affects the disposition of Treasury

obligations in the secondary market, even “in the slightest

degree.” Smith v. Davis, 323 U.S. at 117. A tax that

affected the disposition of a Treasury obligation in the

secondary market by as little as one basis point (one

hundredth of one percent), for example, could, given the

high trading volume in Treasury obligations, result in

wider spreads and impair the price efficiency and liquidity

essential to the smooth operation of the secondary mar-

ket.° A state may not, under the intergovernmental tax

immunity doctrine and Section 3124(a), impose such a

burden on the ability of the federal government to borrow

money without shouldering the same burden with respect

to its own borrowing power.

*Investors purchase Treasury obligations for the purpose of

deriving a positive return, and any reduction of the prospect for

achieving such a return will tend to diminish the price investors are

willing to pay for the obligation (and correlatively tend to increase

the interest-rate cost to Treasury). A hypothetical increase of one

basis point in the interest rate on the Treasury’s marketable securi-

ties would increase the federal government’s cost of borrowing by

over $300 million per year.

In this respect, Ohio must believe that taxation of its own obliga-

tions would adversely affect the market for those obligations, or it

would not have a provision in its State Constitution that bars such

taxation. See Ohio Const., art. VII, § 2K(D) (4).

a i a a a iad

9

II. CERTIORARI SHOULD BE GRANTED TO RE-

SOLVE THE CONFLICT BETWEEN THE DECI-

SION OF THE OHIO SUPREME COURT TO

UPHOLD THIS TAX AND DECISIONS BY OTHER

STATE COURTS INVALIDATING SIMILAR TAXES

In upholding the Ohio statute taxing gains from the

sale of federal debt obligations without taxing gains from

the sale of Ohio obligations, the Ohio Supreme Court

stands alone. Five years ago the Maryland Court of Spe-

cial Appeals invalidated an equally discriminatory tax

assessed by the State of Maryland on gains from the sale

of federal obligations, concluding that “Maryland’s taxa-

tion scheme . . . impermissibly discriminates against hold-

ers of federal obligations by diminishing the investment

attractiveness of the United States obligations in favor of

state obligations.” Doneski, 605 A.2d at 653. The court

in Doneski addressed the legality of a system under which

Maryland never taxed the gain from the sale of its own

obligations, while it taxed the gain realized from selling

a federal obligation whenever the federal government did.

After thoroughly reviewing the history of the intergovern-

mental tax immunity doctrine and Section 3124, the

Maryland court opined that by rendering federal obliga-

tions less attractive to investors, Maryland was “increasing

the cost and decreasing the value of [borrowed] funds to

the federal government. Thus, [Maryland’s] tax structure

adversely affects the ability of the federal government to

raise money and thereby violates the purpose of § 3124.”

Id. at 655 (citation omitted).

Although the tax at issue in Doneski was an individual

income tax, as contrasted to the corporate franchise tax

at issue here, the distinction does not affect the result.

The Ohio Supreme Court, however, reached the opposite

conclusion without citing Doneski.’ The decisions are in

direct conflict.

7 The Ohio Supreme Court could not have effectively distinguished

Doneski, even if it had tried. The Ohio franchise tax is essentially

10

Also prior to the decision of the Ohio Supreme Court

at issue, the Court of Appeals of New York had struck

down a tax scheme that disadvantaged investors in fed-

era! obligations. In Forbes, Inc. v. Department of Finance,

487 N.E.2d 251, the court considered the New York City

General Corporations Tax, which employed a formula

that treated federal obligations differently from other in-

vestments. The court explained that “the City tax unques-

tionably imposes a greater burden on holders of Federal

obligations than on holders of certain other obligations,

and thereby diminishes to some degree the investment at-

tractiveness of Federal obligations.” Jd. at 256. After

surveying the history of Section 3124(a), the court held

the tax system to be impermissible because “the statutory

goal of preserving Federal borrowing power is threatened

whenever any other class of obligations is taxed more

leniently than Federal obligations.” Jd. at 257. This deci-

sion by New York State’s highest court also directly con-

flicts with that of the Ohio Supreme Court.

Previously at least one state revenue department ex-

pressly recognized that a tax such as that imposed by

Ohio would be illegal. See Pennsylvania Dep’t of Rev-

enue Tax Update No. 16, at 4 (July 1987) (“Ask Rev-

enue” column):

Q: Is the gain on the sale of Federal obligations

exempt for Pennsylvania corporate net income tax

purposes?

A: Yes. Since the C.C. Collings case requires the

Department to exclude from taxable income gains

derived from the sale of Pennsylvania state and

municipal obligations, the Department is constitution-

ally obligated to exclude from taxable income the

an income tax, based as it is on the corporation’s net income. See

Pet. 4; Pet. App. 2a. Additionally, although Section 3124 contains

an exception for “a nondiscriminatory franchise tax,” the State has

not contended that Ohio’s corporate franchise tax falls within this

exception.

11

gains derived from the sale of Federal obligations.

This position is consistent with the Department's posi-

tion of excluding interest on Federal obligations from

taxable income. The exclusions of gains derived from

the sale of Federal obligations is also consistent with

the Pennsylvania Supreme Court’s holding in Com-

monwealth v. Curtis Publishing Co., 363 Pa. 299, 69

A.2d 410 (1949).

Also, a Michigan statute by its own terms provides that

the State is “prohibited by law” from subjecting gains and

losses on the sale or exchange of federal obligations to the

State’s income tax:

“Taxable income” means . . . adjusted gross income

as defined in the internal revenue code subject to

the following adjustments

(c) Add losses on the sale or exchange of obliga-

tions of the United States government, the income of

which this state is prohibited from subjecting to a

net income tax, to the extent that the loss has been

deducted in arriving at adjusted gross income.

(d) Deduct, to the extent included in adjusted gross

income, income derived from obligations, or the sale

or exchange of obligations, of the United States gov-

ernment that this state is prohibited by law from

subjecting to a net income tax, reduced by any inter-

est on indebtedness incurred in carrying the obliga-

tions and by any expenses incurred in the production

of that income to the extent that the expenses, includ-

ing amortizable bond premiums, were deducted in

arriving at adjusted gross income.

Mich. Comp. Laws § 206.30(1). |

To date, very few states have tried to do what Ohio

has done here: favor their own state bonds over obliga-

tions issued by the federal government. Currently, Kansas

and Connecticut (in addition to Ohio) tax gains on dis-

positions of federal obligations while not taxing gains on

12

their own obligations.“ Certiorari should be granted to

resolve this conflict now, so states can be properly guided

in choosing their tax structures.

Ill. CERTIORARI SHOULD BE GRANTED TO COR-

RECT THE OHIO SUPREME COURT'S MISINTER-

PRETATION OF SECTION 3124 AND MISAPPLI-

CATION OF THIS COURT’S PRECEDENTS CON-

STRUING THAT STATUTE

Section 3124(a) in one form or another has been in

place since the Civil War and is considered “principally a

restatement of the constitutional rule.” Memphis Bank

& Trust Co., 459 U.S. at 397 (citing New Jersey Title

Ins. Co. v. Division of Tax Appeals, 338 U.S. 665, 672

(1950); Missouri ex rel. Missouri Ins. Co. v. Gehner,

281 U.S. 313, 321-22 (1930)). The statute “estab-

lishe[s] Congressional intent to prevent taxes which di-

minish in the slightest degree the market value or the invest-

ment attractiveness of obligations issued by the United

States in an effort to secure necessary credit.” Smith v.

Davis, 323 U.S. at 117. In 1959, to thwart attempts by

a few states to use a back-door method to tax federal

obligations, Congress added a second sentence to the

original statute: “This exemption extends to every form

’ Several other states tax gains and income on federal obligations

to the extent that such taxation is consistent with the U.S. Consti-

tution and their state constitutions. E.g., Kentucky’s definition of

“lajdjusted gross income” for state tax purposes “[e]xclude[s]

income that is exempt from state taxation by the Kentucky Consti-

tution and the Constitution and statutory laws of the United States

and Kentucky.” Ky. Rev. Stat. Ann. § 141.010(10) (a). Similarly,

for its own taxation Oklahoma adapts the amount of federal

adjusted gross income by “deduct[ing] amounts included in such

income that the state is prohibited from taxing because of the

provisions of the Federal Constitution, the State Constitution, fed-

eral laws or laws of Oklahoma.” Okla. Stat. tit. 68, § 2358.A.2. The

disposition of this case, and, indeed, the petition for certiorari itself,

may affect the position of these other states respecting the coverage

of their tax laws.

13

of taxation that would require that either the obligations

or the interest thereon, or both, be considered, directly or

indirectly, in the computation of the tax, except— non-

discriminatory franchise .. . taxes... .” Pub. L. 86-346,

§ 105(a), 73 Stat. 621. The Senate Report to the bill

that became law explains that the added sentence “makes

it clear that the exemption for Federal obligations extends

to every form of taxation that would require . . . the obli-

. gation . . . to be considered directly or indirectly in the

computation of the tax, except nondiscriminatory fran-

chise taxes... .” S. Rep. No. 86-090, at 5-6 (1959),

reprinted in 1959 U.S.C.C.A.N. 2769, 2773-74.

In “reject[ing] and set[ting] aside” the “rather formalistic

pre-1959 approach to § 3701,” Congress created a “sweep-

ing” exemption for federal obligations. American Bank &

Trust Co., 463 U.S. at 862. The Court in American

Bank & Trust explained that the sentence added in 1959

makes clear that a tax “is barred regardless of its form

if federal obligations must be considered, either directly

or indirectly, in computing the tax.” Jd. (emphasis in

original). In American Bank & Trust, the Court struck

down a Texas bank tax computed by including the value

of the federal obligations held by the banks. 463 U.S.

at 860. Earlier that same Term, in Memphis Bank &

Trust, the Court struck down a Tennessee bank tax on

“net earnings” where “net earnings” was defined to include

income on federal obligations but exclude income on Ten-

nessee obligations. 459 U.S. at 393.

+ el eee eli.

ot cle

As this Court explained in Nebraska Dep’t of Revenue

v. Loewenstein, 513 U.S. 123, 128-29 (1994) (quoting

American Bank & Trust Co., 463 U.S. at 862), “{t]he

obligation itself is ‘considered’ [in the computation of tax]

when its value is ‘taken into account, or included in the

accounting.”” ° The Ohio Supreme Court, however, did

® Loewenstein addressed repurchase agreements in which credit

was extended with federal obligations used as collateral. Interest

14

not address whether taxing the gain from the sale of a

federal obligation required the taxpayer to take the “value”

of that obligation “into account.” Instead the court lim-

ited its inquiry to whether the word “gain” is included

in the text of the exemption. See Pet. App. 4a (“By its

terms, the immunity expressed in Section 3124(a) does

not extend to gains from the sale of federal obligations.” ).

This Court’s prior interpretations of Section 3124(a),

however, dictate a different approach.

As the predicate for its focus on the absence of the

word “gain” in Section 3124(a), the Ohio Supreme Court

looked to the language of Section 3124(b), which speaks

to “the tax treatment of gain and loss from the disposition

of [federal] obligations.” In so doing, the Ohio Supreme

Court “presumed [that Congress had] act[ed] intention-

ally and purposely when it include[d the] particular lan-

guage [regarding gains and losses] in one section of [the]

Statute but omit[ted] it in another.” Pet. App. 4a. The two

provisions, however, have very different histories, and have

only recently been placed together in the same section of

the U.S. Code. No inference from the differing language

can be drawn. See Gozlon-Peretz v. United States, 498

U.S. 395, 404-05 (1991) (employing this principle where

a single enactment contained provisions with differing

language).

The constitutional doctrine of intergovernmental tax

immunity was solely a matter of this Court’s jurisprudence

until the Civil War. See Smith v. Davis, 323 US. at

was paid on the cash extension of credit. The Court held that

Section 3124(a) was not implicated by this extension of credit be-

cause the role of the federal obligations was purely as collateral,

see 513 U.S. at 130-31, and that any other form of “collateral [with]

sufficient value and liquidity” would have served as well. Jd. at 131.

Also in Loewenstein the Court was explicit that any “repos”

using Nebraska’s own state and local obligations as collateral would

be treated no differently than where federal obligations were so

used. See 513 U.S. at 135-36.

15

114-15. When Congress passed the Act of Feb. 25, 1862,

ch. 33, 12 Stat. 345, the doctrine also became embodied

in a federal statute. That statute and six other statutes

were first combined into Section 3701 of the Revised

Statutes and then recodified in 1925 as 31 U.S.C. § 742,

see Smith v. Davis, 323 U.S. at 117 & n.7, and the lan-

guage of that statute remains virtually unchanged as the

first sentence of the present Section 3124(a). In contrast,

United States obligations were exempt from federal taxes

only until 1941, when Congress enacted the Public Debt

Act of 1941, removing their federal tax exempt status.

That statute, as amended, is the present Section 3124(b).

In 1982, these two separate statutory provisions were

recodified as subsections (a) and (b) of Section 3124,

Pub. L. No. 97-258, § 3124, 96 Stat. 877, 945. The

recodification and combination was not intended to change

the meaning of either provision. See Rockford Life Ins.

Co. v. Illinois Dep’t of Revenue, 482 U.S. 182, 183 n.1

(1987). |

In all events, as the Maryland Court of Special Appeals

recognized in Doneski, the inclusion of the terms “gain”

and “loss” in § 3124(b) “would be necessary only if

section (a) prohibits taxing the gain.” 605 A.2d at 651.

The Ohio Supreme Court did not consider this theory of

how the statute should be construed, but instead focused

on a “negative pregnant” construction of Section 3124(a).

Field v. Mans, 516 U.S. 59, 75 (1995). In Field, this

Court explained that application of this rule of construc-

tion should be “limited,” noting that “[t]he more appar-

ently deliberate the contrast, the stronger the inference” to

be drawn from the absent language. 7d. Given the diver-

gent histories of the two provisions, there is no evidence

supporting a conclusion that the distinction between (a)

and (b) was “deliberate” or meaningful in any respect.

In short, the Ohio Supreme Court’s decision that Sec-

tion 3124(a) was not applicable is at odds with this

Court’s interpretation announced in Memphis Bank &

16

Trust and American Bank & Trust of the effect of the

1959 amendment to the statute. There is nothing in the

post-1959 history, including the 1982 recodification, that

affects this Court’s interpretative rulings on the statute.

Certiorari should be granted to address the disparity be-

tween the Ohio Supreme Court’s interpretation of Section

3124(a) and this Court’s prior rulings.

IV. THE OHIO SUPREME COURT’S DECISION CON-

TRAVENES THE INTERGOVERNMENTAL TAX

IMMUNITY DOCTRINE OF FEDERAL CONSTITU-

TIONAL LAW

Certiorari also should be granted because the Ohio

Supreme Court decided a question at the heart of the

intergovernmental tax immunity doctrine in a way that

contravenes decisions of this Court.” Beginning with

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

Court has ruled that a State may not impose taxes directly

on the federal government, nor may a State tax someone

who holds federal instruments or obligations or who deals

with the federal government if that taxation is not “in

common with other property of the same description

throughout the State.” Jd. at 436. The latter prong of

the intergovernmental tax immunity doctrine has been dis-

tilled by this Court into an anti-discrimination rule:

The rule to be derived from this Court’s more recent

decisions, then, is that the economic burden on a fed-

1° That the constitutional question under the intergovernmental

tax immunity doctrine arises separately from the statutory exemp-

tion provided by Section 3124(a) is apparent from this Court’s

analysis in Loewenstein. After first addressing the Nebraska tax

under Section 3124(a), and concluding that the statute did not

apply, the Court addressed whether the tax was forestalled by the

constitutional doctrine. Loewenstein, 518 U.S. at 135-87. See also

Rockford Life Ins., 482 U.S. at 188 (“[Wle shall first decide

whether the statute requires that Ginnie Maes be exempted from

state property taxes, and then consider whether the constitutional

doctrine of intergovernmental tax immunity requires any broader

exemption.”).

17

eral function of a state tax imposed on those who

deal with the Federal Government does not render

the tax unconstitutional so long as the tax is im-

posed equally on the other similarly situated constitu-

ent of the State.

County of Fresno, 429 U.S. at 462. The Ohio Supreme

Court accepted that the franchise tax in Ohio taxes gains

on dispositions of federal obligations and not state obliga-

tions. It nonetheless refused to apply the constitutional

test by ruling that NACCO had not surmounted a rela-

tively high evidentiary hurdle." The barrier thus imposed

contravenes this Court’s precedents.

This Court has tailored the proofs required to invoke

the intergovernmental tax immunity doctrine for two sep-

arate situations, one where the tax discriminates against

those who deal with the federal government and the

other where the tax is not discriminatory. Where discrim-

ination is shown, the Court has adopted a virtual per se

test. See Smith v. Davis, 323 U.S. at 117 (prohibiting

discriminatory state taxes that burden Treasury obliga-

tions “in the slightest degree”); Willcuts v. Bunn, 282

U.S. 216, 229 (1931). By contrast, where the tax is not

discriminatory, the challenger must establish that a fed-

eral governmental function or instrumentality is directly

burdened or impaired. In this latter respect, in Willcuts

v. Bunn, the Court referred to

subjects which fall within the general application of

nondiscriminatory laws, and where no direct burden

is laid upon the governmental instrumentality, and

there is only a remote, if any, influence upon the

exercise of the functions of government.

11 The Ohio Supreme Court held that NACCO had not shown that

the federal government’s functions had been adversely affected or

impeded, Pet. App. 10a, and that the relationship of the federal

government to the private sale of the Treasury bond in the sec-

ondary market was “too attenuated” to invalidate the Ohio fran-

chise tax on the gain from the sale. Pet. App. lla.

18

288 U.S. at 225. See also Loewenstein, 513 U.S. at 135-

37; Rockford Life Ins., 482 U.S. at 189-191; County of

Fresno, 429 U.S. at 460.

In this case, the Ohio Supreme Court was addressing

a discriminatory tax, yet it applied the evidentiary tests

that have been employed in evaluating nondiscriminatory

systems of taxation.

This distinction in evideniiary requirements between

cases addressing discriminatory and evenhanded taxes has

parallels in this Court’s jurisprudence involving the dor-

mant Commerce Clause. Compare City of Philadelphia

v. New Jersey, 437 U.S. 617, 624 (1978) (applying a

“virtually per se rule of invalidity” to laws that discrimi-

nate on their face), with Pike v. Bruce Church, Inc., 397

U.S. 137, 142 (1970) (requiring evenhanded law to be

“upheld unless the burden imposed on such commerce is

clearly excessive in relation to the putative local bene-

fits”). Another analog is found in this Court’s decisions

applying the Privileges and Immunities Clause. See

Toomer v. Witsell, 334 U.S. 385, 396 (1948) (requiring,

once discrimination against nonresidents is demonstrated,

a “substantial reason for the discrimination beyond the

mere fact that they are citizens of other States”). See also

Lunding v. Tax Appeals Tribunal of the State of New

York, No. 96-1462 (argued November 5, 1997).

The intergovernmental tax immunity doctrine is derived

from several different parts of the U.S. Constitution—the

Tax Clause, art. I, § 8, cl. 1, the Borrowing Clause, art. I.

§ 8, cl. 2, the Supremacy Clause, art. VI, cl. 2, and the

structure of the Constitution relating to the roles of the

federal government and of the States. See McCulloch v.

Maryland, 4 Wheat (17 U.S.) at 425-436. Each of these

elements has its place in shaping the doctrine. This case

touches most directly on the Borrowing Clause, and cer-

tiorari should be granted to enable the Court to consider

whether the decision of the Ohio Supreme Court has sub-

19

merged the import of that clause and thus has distorted

the doctrine itself.

CONCLUSION

The petition for a writ of certiorari should be granted.

PAUL SALTZMAN

SARAH M. STARKWEATHER

THE BOND MARKET

ASSOCIATION

40 Broad Street

New York, NY 10004-2373

ERIKA W. NIJENHUIS

CLEARY, GOTTLIEB, STEEN

& HAMILTON

One Liberty Plaza

New York, NY 10006-1470

December 24, 1997

Respectfully submitted,

CHARLES F.. LETTOW

(Counsel of Record)

GIOVANNI P. PREZIOSO

ONNIG H. DOMBALAGIAN

ABBY F.. RUDZIN

CLEARY, GOTTLIEB, STEEN

& HAMILTON

2000 Pennsylvania Ave., N.W.

Washington, D.C. 20006-1801

(202) 974-1500

Counsel for

The Bond Market Association

as Amicus Curiae