Opinion ID: 878336
Heading Depth: 2
Heading Rank: 1

Heading: First Federal was incorrect

Text: In First Federal we held that under 31 U.S.C. § 742 (1976) corporate taxpayers filing tax returns under the Montana corporation license tax law could not be required to include in their reported income, interest earned on federal obligations during the taxable year. The operating paragraph of First Federal follows: The Department argued that the Montana Corporation License Tax is a franchise tax on the privilege of doing business in Montana with the tax based upon or measured by the net income of the taxpayer. Hence, it was argued, that the tax is not on the property (interest income), but is on the privilege. This Court finds the argument to be unpersuasive. It is a distinction without a difference in our opinion. If the franchise tax is on the privilege and the tax is based on the net income, this Court concludes that the tax is on the privilege and the net income. If the net income includes tax-exempt interest, the tax is on exempt income which is prohibited by the specific federal statutes creating the federal obligations and granting the tax exemption ... It also appears to this Court that by the Department's including the tax-exempt interest in net income, the Department is seeking to tax indirectly what it cannot tax directly, in violation of the general rule set forth in 31 U.S.C. 742 (1976) ... 654 P.2d at 498. It is apparent that this Court concluded that, because the corporation license tax laws of this state provided a tax that was measured by net income, the corporation license tax violated federal law in that regard. We now determine that we were erroneous in that conclusion and that the holding in First Federal should be reversed. We base our determination on these factors: (a) the Montana corporation license tax was fashioned after the federal corporation franchise tax statutes; (b) several of our cases preceding First Federal had held the Montana corporation license tax to be a franchise tax; (c) Congress has amended 31 U.S.C. § 742 (1976) to clarify when states may tax federal obligations and interest income; (d) the United States Supreme Court has enunciated the clarifying effect of the present federal statute, 31 U.S.C. § 3124; and (e) one other court has held other acts similar to the Montana corporation license tax valid. We want it understood that we do not reach our determination reversing First Federal because of the tax loss to the state and counties if we were to continue First Federal in effect. If we were not convinced of the error in First Federal, we would reluctantly but candidly advise the legislature to look to other sources of tax revenues. By its terms, section 15-31-101, MCA, the corporation license tax statute, is a franchise tax. It provides in pertinent part: (3) Every corporation ... engaged in business in the state of Montana shall annually pay to the state treasurer as a license fee for the privilege of carrying on business in this state such percentage or percentages of its total net income for the preceding taxable year at the rate hereinafter set forth ... The precursor of section 15-31-101, MCA, came before the Montana Supreme Court in Equitable Life Assurance Company v. Hart, et al. (1918), 55 Mont. 76, 173 P. 1062. Equitable maintained, among other arguments, that because it also paid a special tax for the privilege of conducting an insurance business in the state, it should not be subjected to a further corporation license tax. This Court determined that Equitable was required to pay the Montana corporation license tax even though it paid other insurance license taxes. The Court reviewed the history leading to this statute and pointed out that the Montana corporation license tax followed verbatim the corporate franchise tax in the federal Tariff Act of 1909. This Court then referred to the United States Supreme Court case of Flint v. Stone Tracy Company (1911), 220 U.S. 107, 31 S.Ct. 342, 55 L.Ed. 389. ... In the present case the tax is not payable unless there be a carrying on or doing of business in the designated capacity, and this is made the occasion for the tax, measured by the standard prescribed ... the tax is laid upon the privileges which exist in conducting business with the advantages which inhere in the corporate capacity of those taxed, and which are not enjoyed by private firms or individuals ... It is this distinctive privilege which is the subject of taxation ... 55 Mont. 76, 83, 173 P. 1062, quoting Flint in part. In State v. J.C. Maguire Construction Company (1942), 113 Mont. 324, 328, 125 P.2d 433, 434, this Court said: In all later decisions of this court wherein this tax has been under consideration or has been referred to in any way it has been spoken of as a franchise tax, or license tax, an excise upon the privilege of doing business in the state in a corporate capacity. Cottonwood Coal Company v. Junod, 73 Mont. 392, at page 398, 236 P. 1080; East Helena State Bank v. Rogers, 73 Mont. 210, at page 213, 236 P. 1090; O'Connell v. State Board of Equalization, 95 Mont. 91 at page 118, 25 P.2d 114. It has been clearly distinguished from the license fees exacted upon the grant of privilege and from taxes imposed upon income or property. With the history of judicial interpretation of the act as we have it thus harmonized with other tax measures, and the administration of the law in accordance therewith, the question of the character of the tax is so well settled as to leave no room for doubt or speculation. (Emphasis added.) In Montana Bankers Association v. Department of Revenue (1978), 177 Mont. 112, 580 P.2d 909, this Court construed the Montana bank shares tax act, a property tax, as valid only if it be interpreted to authorize a deduction for the value of federal obligations in computing the bank shares tax basis. This Court relied on the 1959 amendment to 31 U.S.C. § 742 (1976), of which more later. This holding is still effective in Montana. The Montana corporation license tax is not to be considered a property tax. O'Connell v. State Board of Equalization (1933), 95 Mont. 91, 25 P.2d 114. It is quite clear from our holdings prior to First Federal that the Montana corporation license tax was determined by this Court to be a franchise tax and a nonproperty tax. Therefore, our decision in First Federal needs to be reexamined in the light of the language of 31 U.S.C. § 3124 (the successor to 31 U.S.C. § 742 (1976)): (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; and (2) an estate or inheritance tax. (The language found in subdivision (1) and (2) of 31 U.S.C. § 3124(a) is in essence the language found in a 1959 amendment by the Congress to 31 U.S.C. § 742 (1976).) It was the intention of Congress in § 3124 to clarify the states' right to tax federal obligations or interest income in the narrow circumstances described in § 3124. We determine that a nondiscriminatory franchise tax or other nonproperty tax instead of a franchise tax is permissible; and we determine that the Montana corporation license tax is valid as a nondiscriminatory franchise tax. In American Bank and Trust Company v. Dallas County (1983), 463 U.S. 855, 103 S.Ct. 3369, 77 L.Ed.2d 1072, the United States Supreme Court had before it the validity of the Texas tax on bank shares, a property tax. The court considered the Texas tax in the light of the 1959 federal amendment which is now a part of § 3124. Because the 1959 amendment provided for specific exemptions for franchise and estate and inheritance taxes, and conspicuously omitted shares taxes from that group, the Court concluded that Congress meant to bar bank shares taxes to the extent that they consider federal obligations in the computation of a property tax. 103 S.Ct. at 3375. The first part of § 3124(a) bars any form of taxation that would require federal obligations or the interest therefrom to be considered in computing the tax. The language of 3124(a), however, does not preclude the consideration of federal obligations or their interest income in computing a nondiscriminatory franchise tax. In American Bank and Trust Company, supra, the Supreme Court said in looking at the 1959 amendment: Prior to the 1959 amendment, franchise and estate and inheritance taxes measured by the value of federal obligations, like bank shares taxes, were upheld on the theory that the tax was levied on the franchise or the transfer of the property rather than on the ownership interest in the federal securities themselves. By expressly exempting franchise and estate and inheritance taxes from the amended § 3701, Congress manifested its awareness that the new language would broaden significantly the prohibition as it had been construed by the courts. Congress must have believed that franchise and estate and inheritance taxes required federal obligations to `be considered, directly or indirectly, in the computation of the tax'; otherwise, the specific exemptions for these taxes would have been superfluous ... (Emphasis added.) 463 U.S. at ___, 103 S.Ct. at 3375, 77 L.Ed.2d at 1079. Thus, a nondiscriminatory franchise tax levied by a state on a corporation for the privilege of doing business in the state is valid even though, in computing the tax, interest income from federal obligations is included. The reasoning of the United States Supreme Court in American Bank makes it clear that a state may use, directly or indirectly, the interest income on federal obligations to determine corporate nondiscriminatory franchise taxes levied by the state. In Garfield Trust Company v. Director, Division of Taxation, 6 N.J. Tax 462 (1984), a cause in the New Jersey tax court, the New Jersey court upheld the validity of a New Jersey franchise tax in light of 31 U.S.C. § 3124 and the decision in American Bank. New Jersey's corporate franchise tax is determined by the addition of prescribed percentages of net worth and net income allocable to the State of New Jersey. The plaintiff included its holdings of federal obligations and its income from those sources in computing its corporate income tax, paid the tax, and then sued for refund. The refund was denied by the New Jersey taxing authorities and the New Jersey tax court upheld the denial. The legal theory adopted by the New Jersey tax court in reaching its decision is the same as we have expounded here. The decision was based on American Bank which makes it clear that Congress, in 31 U.S.C. § 3124, provided a distinction between nondiscriminatory franchise taxes measured by tax exempt obligations on the one hand, and property taxes otherwise levied directly or indirectly by states on such federal items on the other. We also determine that the Montana corporation license tax is a nondiscriminatory franchise tax. The term nondiscriminatory was made clear by the United States Supreme Court in Memphis Bank and Trust Company v. Garner (1983), 459 U.S. 392, 103 S.Ct. 692, 74 L.Ed.2d 562. The Court said: A state tax that imposes a greater burden on holders of federal property than on holders of similar state property impermissibly discriminates against federal obligations. See, e.g., United States v. County of Fresno, supra [429 U.S. 452] at 462, 50 L.Ed.2d 683, 97 S.Ct. 699 [at 704 (1977)] (`a state tax on those who deal with the Federal Government' is unconstitutional if the tax `is imposed [un]equally on ... similarly situated constituents of the State'). Our cases establish, however, that if the `tax remains the same whatever the character of the [property] may be, no claim can be sustained that this taxing statute discriminates against the federal obligations.' Werner Machine Company v. Director of Division of Taxation, supra [350 U.S. 492] at 493-94, 76 S.Ct. 534 [at 535], 100 L.Ed. 634 [(1956)]. 459 U.S. at 397, 103 S.Ct. at 696, 74 L.Ed.2d at 567. Montana's corporation license tax does not discriminate against holders of federal obligations. It taxes the interest earned by corporate holders of state obligations. Section 15-31-115, MCA, provides: Notwithstanding the provisions of any other law, the income from bonds or other obligations issued by any state or political subdivision of a state are included in gross and net income for purposes of the corporation license tax ...