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States cautioned against discriminatory tax schemes.

Many state legislatures will kick off the new year by taking up the burdensome task of balancing their state budgets in the face of a lagging economy. Elected officials often explore ways to raise revenue without raising their constituents' taxes, this often takes the form of taxes on business, especially those companies that are out of state. However, two recent U.S. Supreme Court decisions refleet the Court's continued intolerance of state statutes that facially discriminate against out-of-state business.

In both Kraft General Foods, Inc, v, Iowa Dept. of Rev. and Finance, 112 Sup. Ct. 2365 (1992), and Chemical Waste Management v. Hunt, 112 Sup, Ct. 2009 (1992), the Court failed to find a compelling justification for the discriminatory measures. Kraft General Foods Kraft challenged an Iowa statute that required inclusion of dividends from foreign subsidiaries, but not domestic subsidiaries, in the corporate tax base. Iowa adopts the Federal corporate income tax base as the starting point for determining Iowa taxable income. The Internal Revenue Code allows corporations to deduct dividends received from domestic corporations. Dividends received from foreign subsidiaries are not deductible, but corporations may avoid double taxation by means of either a foreign tax credit or a deduction for foreign taxes. Most states, including Iowa, do not provide for such a credit.

The U.S. Supreme Court held that the Iowa statute facially discriminated against foreign commerce in violation of the Foreign Commerce Clause. The Court acknowledged that using Federal taxable income as a base for determining Iowa taxable income was simpler for both the government and taxpayers, but concluded that the same administrative simplification goals could have been satisfied by nondiscriminatory means.

At least 10 other states discriminate against foreign-source dividends in a manner similar to Iowa's. States with tax schemes identical to Iowa include New Mexico, Vermont and Pennsylvania. Pennsylvania state officials have indicated that for 1999, tax returns, the state will allow a deduction for dividends received from foreign subsidiaries. If the foreign subsidiary is less than 90% owned, the deduction will be 70%; if the foreign subsidiary is more than 9,0% owned, the deduction will be 80% of the dividend received. Alaska, Colorado, Kansas, Maine, Missouri, Oklahoma, Rhode Island and South Carolina all have laws similar to Iowa's.

Until these statutes are amended, taxpayers in these states should challenge the laws' validity; in addition, refund claims should be considered. Note, however, that Iowa announced that it will honor the Kraft decision on a prospective basis only. In addition, states' inclusion of other income, such as See. 78 gross-up and subpart F income, may also be challenged under a Kraft analysis.

Chemical Waste Management

The U.S. Supreme Court also considered a challenge to Alabama's waste disposal tax. The state imposed a $25.60 per ton base fee on hazardous waste disposal, with an additional $72 per ton fee for waste generated outside the state that is disposed of in Alabama.

The Court concluded that the statute unconstitutionally discriminated against interstate commerce. A state tax that discriminates against interstate commerce will be struck down under the Commerce Clause unless the state can show that the tax furthers a legitimate local purpose and nondiscriminatory alternatives are not available. The Court noted that there was no challenge to the state's purposes of limiting hazardous waste disposal to protect the environment and health of its citizens, but concluded that the state could have used nondiscriminatory means to accomplish these goals.

The Court suggested three nondiscriminatory alternatives for limiting the disposal of hazardous wastes:(1) a per-ton additional fee on all hazardous waste disposed in the state; (2) a per-mile tax on all vehicles transporting hazardous waste within the state; or (3) an evenhanded cap on the total tonnage disposed in the state. These alternatives, however, may place a double burden of taxation on the citizens of the state, i.e., a cost reflected in taxes already being paid by a state's citizens and an additional charge above that amount arising out of one of these alternatives. In October, Georgia enacted legislation that would apply retroactively the higher tax rate to waste generated in-state.

A number of other states, including Oklahoma, Montana and Utah, have taxes that may discriminate against out-of-state waste. In August, the Kansas attorney general issued an opinion that the state's fee on solid waste was unconstitutional in light of Chemical Waste. Taxpayers will want to reevaluate these statutes, and file protective refund claims if appropriate. Some states, including Indiana and South Carolina, have enacted legislation subjecting hazardous waste generated outside the state to the same fee that would be imposed in the state in which the waste is generated if that fee is higher than the amount otherwise imposed. Because of the difference in treatments for waste generated in-state and out-of-state, taxpayers may consider challenging these fees as well.

Whether states will be required to refund taxes collected under discriminatory tax schemes is still undetermined. The U.S. Supreme Court may give additional guidance when it releases its decision in Harper v. Virginia later this term. In Harper, the Court will consider whether its 1989 decision in Davis v. Michigan should be applied retroactively. There the Court held that Michigan could not exempt the pension income of retired state employees from income taxation while continuing to tax the pension income of retired Federal government employees. When taxpayers in other states sought refunds of taxes paid under similar statutes, many state courts concluded that Davis would be honored only prospectively. Harper, hopefully, may give meaningful guidance as to when states must refund taxes collected under these and other unconstitutional laws. From Marianne Evans, CPA, and Jean Walker, Esq., Washington, D..C.
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Author:Walker, Jean
Publication:The Tax Adviser
Date:Jan 1, 1993
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