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Taxing Too Much: State Income Taxes On Interstate Pipelines.

States, counties and municipalities today energetically tax the income of interstate gas pipelines. Those taxes, however, can reach too widely. Despite U.S. Supreme Court decisions narrowing such state power, state tax laws can exceed constitutional limits with poorly drafted provisions like this one (modeled on an actual tax):

Pipeline or other distribution of certain commodities

Any person, firm or corporation engaged in business as a gas company, pipe line company for transporting or carrying natural gas, hydrogen or other similar commodities, distribution company using the means of pipelines for distributing natural gas, hydrogen or similar commodities, shall pay an annual license of two percent (2%) of their total gross receipts.

That tax ("State Tax") on any pipeline's total gross receipts ignores the constitutional requirement to apportion the income to be taxed between instate and out-of-state commerce. Apportionment is based on the idea that state statutes and county and municipal ordinances may not exact more than their fair share of tax from interstate commerce. But that idea can be forgotten, at the pipelines' expense. When it is, the State Tax, or similar taxes, may be challenged as unconstitutionally apportioned and discriminatory under Supreme Court decisions discussed here.

An Introduction Matter: Why isn't the State Tax pre-empted by federal statute?

Certainly, a "broad base" of Natural Gas Act jurisdiction attaches to interstate pipeline transportation.[1] However, the Act, although extending federal regulation to interstate transportation and sale for resale, has no purpose or effect to cut down state power,[2] and does not pre-empt the State Tax.[3]

A Legal Backdrop: The commerce clause on a thumbnail

The U.S. Constitution's interstate commerce clause grants Congress power to regulate commerce among the several states.[4] In the early 19th century, the Supreme Court interpreted the clause to immunize interstate business activity from state taxation--period.[5] In 1931, the Court set aside a Mississippi tax on interstate pipeline gas commodity sales because the gas moved in interstate commerce "that the State cannot touch".[6]

That was then, and this is now. Modern Court decisions no longer immunize interstate commerce from state taxes, whether the tax is called excise, franchise, gross income, gross receipts, license or privilege. With its 1977 Complete Auto Transit v. Brady ruling, the Court both rejects the view that states cannot tax interstate commerce and also places limits on such taxes.[7] As the Court stated in 1994, by negative implication from the commerce clause's positive grant of power to Congress, state taxes may not unjustifiably burden or discriminate against inter: state commerce.[8] No longer will a fairly apportioned and non-discriminatory Louisiana tax on interstate liquefied petroleum pipelines be sustained solely because the phrase "privilege of carrying on or doing business" (which the Court called a "fatal constitutional flaw"[9]) was removed. Also no longer will a Texas tax on interstate pipelines taking natural gas at a processing plant be invalidated because it might have led to "customs barriers", violating a supposed interstate commerce "free trade" immunity from state taxation.[10]

A Supreme Court Standard: Complete Auto Transit examines the "practical effect of a challenged tax".[11]

While the Constitution mandates a free flow of interstate commerce, the states desire interstate business to bear its proper share of the costs of local government in return for benefits received.[12] To resolve the conflict, Complete Auto Transit, instead of "draftsmanship and phraseology," focuses on a tax's "practical effect," balancing burden on interstate commerce with asserted state interests by looking at four factors to sustain a tax (nexus, apportionment, discrimination, relation to benefits provided[13]) as follows:

* Nexus with the state

Only minimal contact is needed. The Court found sufficient nexus for a business selling wholesale volumes of out-of-state pipe and drainage products in Washington, despite the business having no office or employees there, owning no property in Washington, and only marketing its business through a Seattle independent contractor.[14] By comparison, the substantial physical contacts of interstate pipeline facilities built, operated and maintained instate show a State Tax nexus.

* Fair apportionment between in-state and out-of-state business

In Central Greyhound Lines v. Mealey[15] the Court limited New York's taxing of an interstate bus line's unapportioned gross receipts over routes including other states' highways, saying (334 U.S. at 660):
 New York claims the right to tax the gross receipts from transportation
 which traverses New Jersey and Pennsylvania as well as New York. To say
 that this commerce is confined to New York is to indulge in pure fiction.

The Court apportioned the tax only to those receipts for miles traveled in New York, noting the bus line was exposed to taxation by New Jersey and Pennsylvania on portions of the same receipts New York was taxing in their entirety.[16]

That analysis also applies to the State Tax on unapportioned gross receipts from a pipeline crossing several states. Pipeline gas volumes do not appear in the State Tax jurisdiction by magic. This country has about 300,000 miles of high pressure transmission natural gas pipelines.[17] Gas often moves substantial distances before or after crossing a state, and, in most cases, a state's fairly apportioned share of taxable income is less than total gross receipts. But there is no formula in the State Tax to claim only a fair share of tax. No calculation reduces total gross receipts by ratioing the state component of the enterprise to the entire interstate activity (in-state and out-of-state together). As in Central Greyhound, if other states claim their fair share of tax, the part of interstate commerce income on which the unconstitutionally apportioned State Tax would exact more than its fair share would be exposed to multiple taxation.

What apportionment works? The Court makes no rule for all seasons. Major oil company taxable income has been apportioned by averaging three ratios: in-state to total property, in-state to total receipts and in-state to total employee compensation.[18] Single-factor formulae, such as in-state gross sales to total gross sales, have been approved.[19] Apportionment on the in-state employment of capital, plant or other property has supported a liquefied petroleum products common carrier tax.[20] For interstate pipeline gas commodity sellers, taxes apportioned on the value of capital used, invested or employed instate, and on net earnings in-state, have been sustained.[21]

* Lack of discrimination

Given its unlawful apportionment, the State Tax discriminates by definition: "A tax that unfairly apportions income from other States is a form of discrimination against interstate commerce."[22]

* Relation to benefits provided

Is the tax fairly related to state-provided services? Setting both tax amount and benefit value aside, does the business have a state nexus? Yes. If so, does the business have state-afforded opportunities (trained workforce, public facilities) and protections (police and fire)?[23] Again, yes.

Conclusion: Law governing the states also applies to their counties and municipalities.

Counties and municipalities with state-delegated taxing powers should take pains in their ordinances to reach only for income from the interstate business actually done in those state political subdivisions. The smaller the taxing entity then, the more Complete Auto Transit's apportionment and discrimination factors reduce the income to be taxed. State enthusiasms notwithstanding, at some point of diminished returns, taxing interstate pipeline income may be barely worth the candle.

Michel Marcoux is a partner in Bruder, Gentile & Marcoux, L.L.P, a Washington, D.C. law firm specializing in natural gas and electric utility industry work. He principally has represented gas distributors and electric utilities in gas matters before the Federal Energy Regulatory Commission and the Federal Courts. He can be reached at 202-783-1350 or


[1] FPC v. Louisiana Power & Light Company, 406 U.S. 621, 640-41 (1972).

[2] Panhandle Eastern Pipe Line Company v. Public Service Commission, 332 U.S. 507, 516-17 (1947).

[3] Federal and state power to regulate commerce ("a vast field") can be concurrent. Cooley v. Board of Wardens, 53 U.S. (12 How.) 299, 319 (1851).

[4] Art. I, [sections] 8, cl. 3.

[5] Brown v. Maryland, 25 U.S. (12 Wheat.) 419, 445-49 (1827).

[6] State Tax Commission v. Interstate Natural Gas Company, 284 U.S. 41, 43-44.

[7] 430 U.S. 274, 279, 287-89 (upholding a Mississippi privilege income tax on a Michigan corporation transporting motor vehicles, assembled out-of-state and shipped by rail to Mississippi, by truck to Mississippi car dealers); accord Goldberg v. Sweet, 488 U.S. 252, 259 (1989); Northwestern States Portland Cement Company v. Minnesota, 358 U.S. 450, 461-62 (1959).

[8] Oregon Waste Systems v. Environmental Quality Commission, 511 U.S. 93, 98-99, 108 (the Court invalidated a tax on waste generated out-of-state that was three times as high as a tax on waste generated in Oregon).

[9] Colonial Pipeline Company v. Traigle, 421 U.S. 100, 101, 103 & 112 (1975); accord Memphis Natural Gas Company v. Stone, 335 U.S. 80 (1948)(at 87-88: Fairly apportioned, non-discriminatory Mississippi franchise tax "may be invalid" because levied on "privilege" of doing interstate business in-state).

[10] Michigan-Wisconsin Pipe Line Company v. Calvert, 347 U.S. 157, 170 (1954).

[11] Mobil Oil Corporation v. Commissioner of Taxes, 445 U.S. 425, 443 (1980)(upholding fairly apportioned Vermont taxation of New York corporation's dividend income from foreign subsidiaries and affiliates under the Complete Auto Transit four-factor protocol)

[12] Michigan-Wisconsin, supra, 347 U.S. at 166.

[13] 430 U.S. at 276-79, 281, 287.

[14] Tyler Pipe Industries v. Department of Revenue, 483 U.S. 232, 249-51 (1987); accord Exxon Corporation v. Department of Revenue, 447 U.S. 207, 219-24 (1980)(upholding fairly apportioned Wisconsin income tax of entire, vertically integrated oil business doing only in-state marketing).

[15] 334 U.S. 653, 654, 660-64 (1948); see also Oklahoma Tax Commission v. Jefferson Lines, 514 U.S. 175,190 (1995).

[16] Id. at 662-63. The Court sustained a Pennsylvania motor fuel consumption tax on an interstate motor carrier because directly apportioned to the mileage traveled in Pennsylvania. American Trucking Associations v. Scheiner, 483 U.S. 266, 283 (1987).

[17] U.S. Department of Energy, Energy Information Administration, Pub. No. DOE/EIA-0560, Natural Gas 1998 Issues and Trends, 49 (June 1999).

[18] Amerada Hess Corporation v. Division of Taxation, 490 U.S. 66, 70, 73 (1989).

[19] Moorman Manufacturing Company v. Bait, 437 U.S. 267, 270, 273, 276-80 (1978).

[20] Colonial Pipeline, supra, 421 U.S. at 103-04 & n.4.

[21] Memphis Natural Gas, supra, 335 U.S. at 82; Memphis Natural Gas Company v. Beeler, 315 U.S. 649, 652-56 (1942); Southern Natural Gas Corporation v. Alabama, 301 U.S. 148, 150, 156-57 (1937).

[22] Armco v. Hardesty, 467 U.S. 638, 644 (1984).

[23] Commonwealth Edison Company v. Montana, 453 U.S. 609, 625-27 (1981).
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Author:Marcoux, J. Michel
Publication:Pipeline & Gas Journal
Date:May 1, 2000
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