State tax incentives after Cuno.

States have become very competitive in trying to attract new businesses and keep existing ones. To entice them, many states offer tax incentives for the construction or improvement of facilities, purchase of capital equipment or employment of additional staff. In fact, over 80% of the states have some form of investment credit for new investments in property or labor. Such incentives were potentially in jeopardy as a result of an Ohio class-action suit, Charlotte Cuno v. DaimlerChrysler, Inc., 154 FSupp2d 1196 (ND OH 2001).

Background

Facts: Ohio offers several types of incentives for businesses that locate new property in the state. Its manufacturing credit allowed taxpayers a credit against its state income or franchise tax liability of 7.5%-13.5% of the cost of new manufacturing equipment additions that exceeded a base-period threshold. For new taxpayers in the state, the base-period threshold was zero; thus, the taxpayer would receive a credit for all purchases of manufacturing machinery and equipment. Additionally, a taxpayer could receive an abatement of personal property tax on equipment and inventory if it negotiated an enterprise-zone agreement with the local government. As a result of building a new facility near Toledo, DaimlerChrysler was to receive both manufacturing credits and abatements of personal property taxes.

To entice DaimlerChrysler to remain in Toledo and construct a new vehicle-assembly plant near its existing facility, the state granted it approximately $280 million in tax abatements and credits. The plaintiffs were a group of individuals who felt they were damaged by this grant. They contended that the Ohio state income tax credits and the personal property tax abatements discriminated against interstate commerce, by granting preferential treatment to instate investment and activity in violation of the Commerce Clause.

According to Complete Auto Transit v. Brady, 430 US 274, 277 (1977), a state tax violates the Commerce Clause if it:

* Lacks sufficient nexus with the state;

* Discriminates against interstate commerce;

* Is unfairly apportioned; or

* Is unrelated to services provided by the state.

District court's decision: The district court determined that neither the credits nor the abatements violated the Commence Clause, because they did not violate either of the taxation structures that have been previously rejected by the Supreme Court, and they did not discriminate against interstate commence.

The Supreme Court has rejected two categories of taxation schemes. The first is a system that acts as a protective tariff or customs duty, which taxes goods imported from other states, but does not tax similar products produced in-state; see West Lynn Creamery, Inc. v. Healy, 512 US 186, 193 (1994). Clearly, the property tax exemption is not a tariff, as it applies only to property owned in Ohio. If a potential taxpayer is unhappy with the effect of the exemption, it is free to relocate to another state and conduct all the business that it wishes to, without further consequence. Similarly, the manufacturing credit is not a tariff, because it does not burden the transfer of goods in interstate commerce. Instead, it is available equally to businesses regardless of their initial location, as long as they increase the amount of their Ohio investment.

The second inappropriate scheme rejected by the Supreme Court involves discriminatory taxation based on the proportion of a business's activity within a state, as compared to business done in other states. An example is the New York law found unconstitutional in Westinghouse Elec. Co. v. Tully, 466 US 388 (1984). In Westinghouse, the Supreme Court addressed a New York law that taxed corporate income, but returned a portion of that tax as a credit based on the proportion of total business activity conducted in that state. This is similar to the credit and exemption schemes at issue in Cuno, because an increase in activity in Ohio could increase the credit and the exemption amounts. However, the Westinghouse credit had a crucial difference--an increase in activity conducted outside New York would decrease the amount of the credit. As to the Ohio manufacturing credit and property tax abatement, neither amount varied with increased activity outside Ohio.

Subsequent Disposition

Sixth Circuit: The case was appealed to the Sixth Circuit; see Charlotte Cuno v. DaimlerChrysler, Inc., 6th Cir., 9/2/04, amended op., 383 F3d 379 (6th Cir. 2004). The court reversed the portion of the district court's judgment that held the manufacturing tax credit Constitutional. The court reasoned that between two businesses, otherwise similarly situated and each subject to taxation, the business that chooses to expand its local presence in Ohio will enjoy a reduced tax burden, based directly on its new in-state investment, while a competitor that invests out-of-state will face a comparatively higher tax burden, because it will be ineligible for any credit against its Ohio tax. Thus, similar to the result in Westinghouse, the Ohio manufacturing credit was deemed in violation of the Commerce Clause, because it discriminated against interstate commerce--it encouraged further investment in Ohio at the expense of development in other states. The court found the personal property tax exemptions to be Constitutional, however, because only businesses with property in Ohio were subject to that tax.

Supreme Court: As a result of the use of these types of investment incentives in many states, the Supreme Court granted certiorari; see DaimlerChrysler Corp. v. Charlotte Cuno, S.Ct., 5/15/06. Surprisingly, the Court determined that the plaintiffs did not have standing to press their complaint in Federal court. "Standing" means that a plaintiff must allege a personal injury fairly traceable to the defendant's allegedly unlawful conduct and likely to be redressed by the requested relief. The Court applied a narrow definition and rejected the plaintiffs' arguments of standing based on their status as Ohio taxpayers. Standing has been rejected in such cases, because the alleged injury is not concrete or particularized. The Court concluded that because the plaintiffs had not established standing to challenge the credit, the lower courts erred by considering their claims.

Conclusion

As a result of the Supreme Court's analysis, the many states that have these types of credits can continue to offer tax incentives to entice business to invest therein. However, tax advisers may never know the real answer to the question whether state tax incentives for locating people and property in a state violate the Commerce Clause. Subsequent to this litigation, Ohio massively reformed its tax structure and converted the tax credit program to a grant program, which is in the process of expiring.

FROM TRACY J. MONROE, CPA, MT, COHEN & COMPANY, LTD., AKRON, OH