Title: NACCO Industries, Inc. v. Tracy

State: ohio

Issuer: Ohio Supreme Court

Document:

NACCO INDUSTRIES, INC., APPELLANT, v. TRACY, TAX COMMR., APPELLEE. 
[Cite as NACCO Industries, Inc. v. Tracy (1997), 79 Ohio St.3d 314.] 
Taxation — Corporation franchise tax — Gain from the sale of a United States 
Treasury Bond not exempt from Ohio franchise tax — Section 3124, Title 
31, U.S.Code, construed. 
(No. 96-1535 — Submitted May 6, 1997 — Decided August 6, 1997.) 
APPEAL from the Board of Tax Appeals, No. 95-K-1210. 
 
In 1982, NACCO Industries, Inc. (“NACCO”) purchased, for $6,100,003, a 
fifteen-year U.S. Treasury Bond in the principal amount of $8,000,000.  Seven 
years later, NACCO sold the bond for $7,694,071, of which $126,575 represented 
accrued, but unpaid, interest.  NACCO did not include its $1,467,493 gain from 
the sale of the bond in the calculation of its 1990 Ohio franchise tax. 
 
NACCO objected to the inclusion of the gain on the basis that the Ohio 
franchise tax impermissibly discriminated against federal obligations because it 
exempted gains only from the sale of Ohio public obligations. The Ohio 
Department of Taxation disagreed, included the $1,467,493 gain in NACCO’s net 
income, and increased the assessment in the amount of $116,202.  Upon 
NACCO’s petition for reassessment, the Tax Commissioner affirmed the $116,202 
assessment plus $37,343 in interest.  The Board of Tax Appeals affirmed the final 
determination of the Tax Commissioner. 
 
This cause is now before the court upon an appeal as of right. 
__________________ 
 
Jones, Day, Reavis & Pogue and Charles M. Steines, for appellant. 
 
Betty D. Montgomery, Attorney General, and Richard C. Farrin, Assistant 
Attorney General, for appellee. 
__________________ 
2 
 
COOK, J.  Ohio corporations calculate their franchise tax on both a net worth 
basis and a net income basis and pay whichever produces the greater tax.  R.C. 
5733.06.  In this case, the relevant calculation is net income.  The initial base for 
the net income tax is federal taxable income before net operating loss and special 
deductions.  R.C. 5733.04(I).  From that figure, Ohio corporations are permitted to 
“[a]dd any loss or deduct any gain resulting from the sale, exchange, or other 
disposition of public obligations to the extent included in federal taxable income.” 
R.C. 5733.04(I)(6).  For purposes of R.C. 5733.04(I)(6), a “public obligation” is 
defined as a “public security.”  R.C. 5733.04(I)(5), 5709.76(D)(5).  A “public 
security,” in turn, is defined as “bonds, notes, certificates of indebtedness, 
commercial paper, and other instruments in writing issued by a state or a 
subdivision.”  (Emphasis added.)  R.C. 5709.76(D)(6). 
 
The effect of these definitions is that gain from the sale of an Ohio 
obligation is exempt from the Ohio franchise tax,1 while gain from the sale of a 
federal obligation is not.  We decide here whether this taxing scheme violates 
Section 3124, Title 31, U.S.Code, or is unconstitutional under the doctrine of 
intergovernmental immunity as embodied in the Supremacy Clause of the United 
States Constitution.  We conclude that Ohio’s corporate franchise tax scheme 
violates neither the statute nor the constitutional doctrine. 
 
With the famous declaration that "the power to tax involves the power to 
destroy," McCulloch v. Maryland (1819), 17 U.S. (4 Wheat.) 316, 431, 4 L.Ed. 
579, 607, Chief Justice John Marshall announced the doctrine of federal immunity 
from state taxation.  In McCulloch, the court considered Maryland’s imposition of 
a tax on notes issued by any bank established without its authority.  The only bank 
falling into that category was the Bank of the United States.  Chief Justice 
Marshall explained that the federal government “though limited in its powers, is 
3 
supreme within its sphere of action.”  Id. at 405, 4 L.Ed. at 601.  Although both 
sovereigns could impose taxes, the court held that a state does not have authority 
to tax an instrument employed by the federal government in the execution of its 
power.  Id. at 432, 4 L.Ed. at 608. 
 
From McCulloch evolved the doctrine of intergovernmental tax immunity.  
In Metcalf & Eddy v. Mitchell (1926), 269 U.S. 514, 521, 46 S.Ct. 172, 173-174, 
70 L.Ed. 384, 391, the court explained that “the very nature of our constitutional 
system of dual sovereign governments is such as impliedly to prohibit the federal 
government from taxing the instrumentalities of state government, and in a similar 
manner to limit the power of the states to tax the instrumentalities of the federal 
government.” 
 
In its early development, the doctrine of intergovernmental immunity was 
construed to insulate not only direct government functions from taxation, but also 
derivative transactions relating to the performance of governmental functions.  2 
Rotunda & Nowak, Treatise on Constitutional Law (2 Ed.1992) 300, Section 13.9.  
Ultimately, the court expanded the doctrine to prohibit both a state income tax on 
federal employees and a federal income tax on state employees.  Dobbins v. Erie 
Cty. Commrs. (1842), 41 U.S. (16 Pet.) 435, 10 L.Ed. 1022; The Collector v. Day 
(1870), 78 U.S. (11 Wall.) 113, 20 L.Ed. 122. 
 
In modern times, however, the Supreme Court has adopted “a functional 
approach to claims of intergovernmental immunity, accommodating of the full 
range of each sovereign’s legislative authority and respectful of the primary role of 
Congress in resolving conflicts between the National and State governments.” 
North Dakota v. United States (1990), 495 U.S. 423, 435, 110 S.Ct. 1986, 1994, 
109 L.Ed.2d 420, 433.  Abandoning its early beginnings, the court apparently has 
eroded the doctrine to the following:  “So long as the tax is not directly laid on the 
4 
Federal Government, it is valid if nondiscriminatory * * * or until Congress 
declares otherwise.”  United States v. Fresno Cty. (1977), 429 U.S. 452, 460, 97 
S.Ct. 699, 704, 50 L.Ed.2d 683, 691. 
 
By enacting Section 3124, Title 31, U.S.Code (“Section 3124”), Congress 
has “declared otherwise” on the subject of immunity from state taxation for federal 
obligations.  Because the statutory immunity codified at Section 3124(a) is 
principally a restatement of the constitutional rule, Rockford Life Ins. Co. v. 
Illinois Dept. of Revenue (1987), 482 U.S. 182, 187-188, 107 S.Ct. 2312, 2315, 96 
L.Ed.2d 152, 159, we first view the case at bar under the statutory immunity and 
then consider whether the constitutional doctrine of intergovernmental immunity 
requires a broader exemption. 
 
Section 3124 states, in part: 
 
“(a) 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 nonproperty tax instead of a franchise 
tax, imposed on a corporation * * *.” 
 
Under this section, the scope of the immunity from state taxation granted by 
Congress extends only to federal obligations and the interest on such obligations.  
By its terms, the immunity expressed in Section 3124(a) does not extend to gains 
from the sale of federal obligations.   In contrast, Section 3124(b), Title 31, 
U.S.Code, regarding federal taxation of federal obligations, incorporates the 
phrase “tax treatment of gain and loss from the disposition of those [federal] 
obligations.”  Congress is generally presumed to act intentionally and purposely 
when it includes particular language in one section of a statute but omits it in 
5 
another.  Chicago v. Environmental Defense Fund (1994), 511 U.S. 328, 338, 114 
S.Ct. 1588, 1593, 128 L.Ed.2d 302, 311.  Had Congress intended Section 3124(a) 
immunity to extend to gains from the sale of federal obligations, it would have 
expressed that intent in the statute.  See California State Bd. of Equalization v. 
Sierra Summit, Inc. (1989), 490 U.S. 844, 854, 109 S.Ct. 2228, 2235, 104 L.Ed.2d 
910, 920. 
 
Moreover, in Nebraska Dept. of Revenue v. Loewenstein (1994), 513 U.S. 
123, 115 S.Ct. 557, 130 L.Ed.2d 470, the court upheld a state tax upon interest 
earned from repurchase agreements involving federal securities under Section 
3124.  Under these repurchase (“repo”) agreements, the owner of the securities 
agreed to sell and repurchase the securities at a fixed increased price.  The original 
seller retained the interest earned by the securities during the term of the repo 
agreement.  The state exempted from tax the interest paid by the federal 
government on the federal obligations, but assessed an income tax against the 
interest paid as a result of the repurchase agreements. 
 
In upholding the state tax, the court found the dispositive question to be 
whether the interest at issue was earned on the obligations of the United States 
government.  For purposes of Section 3124, the court concluded, the interest was 
not attributable to redemption of the securities or payment by the United States 
government.  Rather, the interest was income earned as interest on loans to private 
parties.  Thus, the court concluded that the income being taxed by the state was 
not interest from the federal securities and Section 3124 did not prohibit the state 
from taxing the income. 
 
We similarly find that the dispositive question in this case is whether the 
income at issue was earned on the obligations of the United States.  The income at 
issue here is not attributable to redemption of the obligations or payment by the 
6 
United States government.  Rather, the income is attributable to a contractual 
relationship between two private parties.  Accordingly, we hold that Section 3124 
immunity from state taxation does not extend to Ohio’s corporate franchise tax 
upon the gain from the sales of federal obligations and such a tax is not prohibited 
by that statute. 
 
We turn now to consider whether the constitutional doctrine of 
intergovernmental immunity requires any broader exemption than the statute.  
Before we proceed, however, we are mindful of the Supreme Court’s caveat that a 
“court must proceed carefully when asked to recognize an exemption from state 
taxation that Congress has not clearly established.  We do well to remember the 
concluding words in Smith [v. Davis (1944), 323 U.S. 111, 119, 65 S.Ct. 157, 161, 
89 L.Ed. 107, 113], which although spoken in reference to the statute, are relevant 
to our role in applying the constitutional doctrine as well:  ‘All of these related 
statutes are a clear indication of an intent to immunize from state taxation only the 
interest-bearing obligations of the United States which are needed to secure credit 
to carry on the necessary functions of government.  That intent, which is largely 
codified in § 3701, should not be expanded or modified in any degree by the 
judiciary.’”  Rockford Life Ins. Co., 482 U.S. at 191, 107 S.Ct. at 2317-2318, 96 
L.Ed.2d at 161.  “[A]bsent congressional action,” the court has emphasized, “the 
States’ power to tax can be denied only under the ‘clearest constitutional 
mandate.’”  (Citation omitted.)  United States v. New Mexico (1982), 455 U.S. 
720, 738, 102 S.Ct. 1373, 1384, 71 L.Ed.2d 580, 594. 
 
In Rockford Life Ins. Co., the court considered whether “Ginnie Maes,” 
financial instruments issued by private financial institutions and guaranteed by the 
Government National Mortgage Association, were exempt from state taxation by 
either statutory or constitutional intergovernmental immunity.  In considering the 
7 
constitutional immunity, the court turned to the purpose of the constitutional 
doctrine.  The doctrine, the court noted, is based on the proposition that “the 
borrowing power is an essential aspect of the Federal Government’s authority and, 
just as the Supremacy Clause bars the States from directly taxing federal property, 
it also bars the States from taxing federal obligations in a manner which has an 
adverse effect on the United States’ borrowing ability.”  Id. at 190, 107 S.Ct. at 
2317, 96 L.Ed.2d at 160. 
 
The court considered the lack of a fixed and certain obligation by the United 
States on Ginnie Maes “far too attenuated” from the doctrine’s concern with the 
borrowing power of the United States to support constitutional immunity.  Id.  The 
court also considered that none of the proceeds from the sale of Ginnie Maes was 
received by the federal government or used to finance any federal function.  Id. at 
191, 107 S.Ct. at 2317, 96 L.Ed.2d at 161. 
 
In Willcuts v. Bunn (1931), 282 U.S. 216, 51 S.Ct. 125, 75 L.Ed. 304, the 
court upheld a federal tax upon gains from the sale of state and municipal 
obligations after a challenge based upon the doctrine of intergovernmental 
immunity.  There, the court rejected the notion that a prohibition of a tax on the 
interest payable on state and municipal bonds also prohibited a tax upon the 
profits derived from a sale of such bonds.  Id. at 227, 51 S.Ct. at 127, 75 L.Ed. at 
308.  The court observed that the sale of bonds by their owners “is a transaction 
distinct from the contracts made by the government in the bonds themselves, and 
the profits on such sales are in a different category of income from that of the 
interest payable on the bonds.”  Id.  The court further noted that “[t]he tax upon 
interest is levied upon the return which comes to the owner of the security 
according to the provisions of the obligation and without any further transaction 
on his part.  The tax falls upon the owner by virtue of the mere fact of ownership, 
8 
regardless of the use or disposition of the security.  The tax upon profits made 
upon purchases and sales is an excise upon the result of the combination of several 
factors, including capital investment and, quite generally, some measure of 
sagacity; the gain may be regarded as ‘the creation of capital, industry and skill.’”  
(Citation omitted.)  Id. at 227-228, 51 S.Ct. at 127-128, 75 L.Ed. at 308. 
 
The court found particularly persuasive the fact that in a “uniform and long-
established practice * * * neither the Federal Government nor the States have 
found a tax on the profits of the sales of their securities to be a burden on their 
power to borrow money.  So far as we are advised, the Federal Government has 
not at any time deemed it to be necessary to exempt from taxation the profits 
realized by owners on the sale of its obligations, with the exception, recently 
made, of short-term Treasury bills issued on a discount basis and payable without 
interest.”  Id. at 232, 51 S.Ct. at 129, 75 L.Ed. at 310. 
 
The Willcuts court additionally observed that “it may be doubted whether 
the prospect on the part of the ordinary investor of obtaining profit on the resale of 
such obligations is so important an element in inducing their acquisition that a 
federal tax laid on such profits, in common with profits derived from the sales of 
other property, constitutes any substantial interference with the functions of state 
governments.  While the tax is laid on gains, there is also a deduction for losses on 
sales, and whether investors in such securities would consider it an advantage if 
both provisions were eliminated is a matter of mere speculation. * * * [B]efore we 
can restrict their application upon the ground of a burden cast upon the State’s 
borrowing power, where the state tax is not laid upon contracts made by the State 
in the exercise of that power, or upon the amounts payable thereunder, but is laid 
upon the result of distinct transactions by private owners, it must clearly appear 
that a substantial burden upon the borrowing power of the State would actually be 
9 
imposed.  But we have nothing but assertion and conjecture.”  282 U.S. at 231, 51 
S.Ct. at 129, 75 L.Ed. at 310. 
 
 
From these precedents, it is apparent that the limits of the constitutional 
doctrine do not extend to a state tax upon gains from the proceeds of a contract 
between two private parties where there is no demonstrable burden on the federal 
borrowing power.  The nexus between the federal government and the exchange of 
a federal obligation among private parties is “far too attenuated” from the 
doctrine’s concern with the effect of the tax upon the borrowing power of the 
United States to support constitutional immunity.  Rockford Life Ins. Co., 482 U.S. 
at 190, 107 S.Ct. at 2317, 96 L.Ed.2d at 160. 
 
Ohio taxes the proceeds from a transaction between two private parties, a 
transaction distinct from that of the interest payable on the bonds or the amount 
payable on the bond itself.  The profits from the transaction are realized entirely by 
the owner of the obligation.  None of the proceeds from the sale of the obligations 
was received by the federal government or used to finance any federal function.  
We have no evidence clearly establishing that a substantial burden on the federal 
government’s borrowing power would actually be imposed.   
 
Section 3124 is an indication of an intent to immunize only the federal 
obligation or the interest on the obligation from state taxation.  Until Congress, in 
its primary role of resolving conflicts between the national and state governments, 
expressly resolves this conflict to the contrary, we decline to extend the 
constitutional limits of the immunity doctrine any further than that provided by 
Section 3124.  As a result, we find that neither the statutory nor the constitutional 
intergovernmental immunity doctrine prohibits Ohio’s corporate franchise tax on 
the gains from the sale of federal obligations. 
10 
 
NACCO argues that our inquiry cannot end here.  NACCO contends that 
under the constitutional doctrine of intergovernmental immunity, any state tax that 
discriminates against those who deal with the federal government is invalid.  We 
note, however, that under the modern doctrine of intergovernmental immunity, 
“[s]o long as the tax is not directly laid on the Federal Government, it is valid if 
nondiscriminatory * * * or until Congress declares otherwise.”  (Emphasis added.)  
Fresno Cty., 429 U.S. at 460, 97 S.Ct. at 704, 50 L.Ed.2d at 691.  Since we have 
determined that Congress has declared otherwise, and we have declined to expand 
the limits of that immunity further, Ohio’s franchise tax is valid, regardless of 
whether it is discriminatory. 
 
Even assuming that we must consider whether the tax is discriminatory, we 
would nevertheless uphold Ohio’s corporate franchise tax.  A state tax 
impermissibly discriminates against federal obligations where it imposes a greater 
burden on holders of federal property than it does on holders of similar state 
property.  Id.  The nondiscrimination rule, however, remains rooted in the 
principle that the state may not obstruct the activities of the federal government. 
North Dakota, 495 U.S. at 437-438, 110 S.Ct. at 1996, 109 L.Ed.2d at 435.  With 
this principle in mind, we find persuasive the Tax Commissioner’s argument that 
in order to establish that the Ohio franchise tax discriminates against federal 
obligations, NACCO must demonstrate that any difference in treatment between 
state and federal obligations affects or impedes a function of the federal 
government; in this case, the marketability of federal obligations.  To this end, 
NACCO’s expert testified that in his opinion, the exclusion of gain from the sale 
of state obligations but not federal obligations would place federal obligations at a 
disadvantage in the market. 
11 
 
At first glance, this argument appears to support NACCO.  In analyzing the 
constitutionality of a state law, however, it is inappropriate for a court to look to 
the most narrow provision addressing the issue.  North Dakota, 495 U.S. at 438, 
110 S.Ct. at 1996, 109 L.Ed.2d at 435.  Rather, a determination of whether a tax is 
discriminatory requires an examination of the state’s whole tax structure. 
Washington v. United States (1983), 460 U.S. 536, 542, 103 S.Ct. 1344, 1348, 75 
L.Ed.2d 264, 271.  Accordingly, we consider that in addition to requiring 
corporations to “deduct any gain” on the sale of a state obligation, R.C. 
5733.04(I)(6) also requires corporations to “add any loss” on the sale of a state 
obligation in calculating its net income basis. 
 
NACCO’s expert testified that the add back of losses from the sale of state 
obligations but not federal obligations would place federal obligations at a market 
advantage.  However, NACCO’s expert could not express 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 in the calculation 
of net income basis.  More than mere conjecture or speculation is required to 
establish that a tax is unconstitutional.  Rockford Life Ins. Co., 482 U.S. at 190, 
107 S.Ct. at 2317, 96 L.Ed.2d at 160, fn. 10. 
 
NACCO cites Memphis Bank & Trust Co. v. Garner (1983), 459 U.S. 392, 
103 S.Ct. 692, 74 L.Ed.2d 562, as support for the argument that Ohio’s tax 
discriminates against federal obligations.  In Memphis Bank, the court found a 
Tennessee state tax on interest earnings from federal obligations but not on 
interest earnings from state obligations violated Section 3124.  We find this case 
distinguishable.  In Memphis Bank, the tax upon the interest of a federal obligation 
fell within the scope of Section 3124.  Thus, Congress already made the 
determination that a state tax on the interest of federal obligations would 
12 
substantially affect a function of government.  Here, however, the tax on the gain 
from the sale of federal obligations does not fall within the scope of Section 3124 
and NACCO has not otherwise established that the state tax at issue affects a 
function of government. 
 
We also consider that a state tax is invalid only if it discriminates against 
the federal government or those with whom it deals.  Id. at 397, 103 S.Ct. at 696, 
74 L.Ed.2d at 567.  Here, the transaction subject to the tax does not arise directly 
from the relationship between the taxpayer and the federal government.  Rather, 
the transaction subject to the tax arises from a contractual relationship between 
two private parties.  We find this relationship to the federal government too 
attenuated to invalidate the Ohio franchise tax.  Accordingly, we find that NACCO 
has failed to establish that the franchise tax discriminates against the federal 
government or those with whom it deals. 
 
Because we find that Ohio’s corporate franchise tax violates neither the 
statutory intergovernmental immunity nor constitutional intergovernmental 
immunity, we affirm the decision of the Board of Tax Appeals. 
Decision affirmed. 
 
MOYER, C.J., DOUGLAS, F.E. SWEENEY, PFEIFER and LUNDBERG STRATTON, 
JJ., concur. 
 
RESNICK, J., concurs in judgment only. 
FOOTNOTE: 
1. 
Notably, this exemption from state taxation for state obligations is necessary 
to comply with the Ohio Constitution.  Section 2k(D)(4), Article VIII of the Ohio 
Constitution exempts from taxation the interest and other income, including 
profits from sales, from bonds issued for the purpose of financing or assisting in 
13 
the financing of the cost of public infrastructure capital improvements of 
municipal corporations, counties, townships and other governmental entities.