Opinion ID: 1676180
Heading Depth: 1
Heading Rank: 4

Heading: corporate shares tax

Text: We turn our attention to the constitutional questions to be considered with respect to the tax on corporate shares. As previously stated, KRS 132.020(1) levies an ad valorem tax of 25 cents upon each one hundred dollars ($100) of value of all money in hand, shares of stock. . . . KRS 136.030(1), the exemption statute, however, exempts the individual stockholders from paying this tax when the corporation [in which they own shares] pays taxes to the state of Kentucky on at least 75% of its total property, wherever located. Appellants argue that this exemption is unconstitutional under U.S. Const. Art. I, sec. 8, Cl. 3, the commerce clause; the 14th Amendment, the equal protection clause; and Kentucky Constitution sections 3 and 171. We will first address Appellants' contentions regarding the equal protection clause of the United States Constitution and secs. 3 and 171 of the Kentucky Constitution. The Court of Appeals concluded that existing precedent in the case of Klein v. Jefferson County Board of Tax Supervisors, 230 Ky. 182, 18 S.W.2d 1009 (1929), aff'd, 282 U.S. 19, 51 S.Ct. 15, 75 L.Ed. 140 (1930), is the guiding case law on this issue. We agree. In Klein , a similar exemption statute was challenged as being arbitrary and in violation of the equal protection clause. The appellant owned shares in a corporation where less than 75 per cent of [its] total property was taxable in Kentucky. Klein, 282 U.S. 19, 22, 51 S.Ct. 15, 15 (1930). He maintained that the discrimination between himself and holders of stock in a corporation paying taxes on more than 75 per cent of all their property is arbitrary and denies to him the equal protection of the laws. Id. The United States Supreme Court held that fixing the percentage of ownership at 75 per cent was a reasonable effort to do justice to all in view of the way all our other assessments are made. Id. at 23, 51 S.Ct. at 16. The Klein Court held that this reasonable effort satisfied the equal protection challenge. All that is required is a rational relationship of the tax to the objective of the tax. The Revenue Cabinet has argued that one objective of the exemption is to avoid double taxation. In effect, this exemption allows the Commonwealth to collect ad valorem taxes only once from owners of a corporation. Therefore, the rational relation exists, and, as a result we hold that there is no violation of the equal protection clause as to the taxation of corporate shares. This is not the end of our constitutional analysis, however. Now, we must turn to the commerce clause and its limiting effect on this statutory provision. Appellants assert that the corporate shares tax scheme patently discriminates against interstate commerce by imposing a greater tax burden on shares of stock held in corporations that do not locate 75% or more of their property in the state of Kentucky than those who do. The commerce clause states the Congress shall have power . . . to regulate commerce with foreign Nations, and among the several States. . . . U.S. Const. Art. I, sec. 8, Cl. 3. The most basic principle of the commerce clause is to create an area of free trade among the several states. McLeod v. J.E. Dilworth Co., 322 U.S. 327, 331, 64 S.Ct. 1023, 1026, 88 L.Ed. 1304 (1944). The commerce clause . . . is a limitation upon the power of the states. Freeman v. Hewit, 329 U.S. 249, 253, 67 S.Ct. 274, 276, 91 L.Ed. 265 (1946). No state may impose a tax which discriminates against interstate commerce. . . by providing a direct commercial advantage to local business. Northwestern States, 358 U.S. at 459, 79 S.Ct. at 362. Allowing states, through legislative enactments to create commercial advantages for local areas invite[s] a multiplication of preferential trade areas destructive of the free trade which the clause is intended to protect. Dean Milk Company v. Madison, 340 U.S. 349, 357, 71 S.Ct. 295, 299, 95 L.Ed. 329 (1951). As a result of these basic principles, the [commerce] clause has long been understood to have a `negative' aspect that denies the states the power unjustifiably to discriminate against or burden the interstate flow of articles of commerce. Oregon Waste Systems v. Dept. of Env. Quality, ___ U.S. ____, ____, 114 S.Ct. 1345, 1349, 128 L.Ed.2d 13 (1994). Due to this effect of the commerce clause, legislatures and courts have been confronted with questions addressing the taxing powers of a state. The central theme of these cases is the creation of a dividing line between the constitutional goal of developing a national free-flowing economy and the individual state's need for a revenue source. Where this line is drawn turns on the unique characteristics of the statute at issue and the particular circumstances in each case. Boston Stock Exchange v. State Tax Commission, 429 U.S. 318, 330, 97 S.Ct. 599, 606, 50 L.Ed.2d 514 (1977). See also, Freeman v. Hewit, 329 U.S. at 253, 67 S.Ct. at 276 (1946). The United States Supreme Court opinions of Oregon Waste and Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 97 S.Ct. 1076, 51 L.Ed.2d 326 (1977), provide guidance as to the analytical process in determining the validity of a state tax. The Court of Appeals addressed the four part test set forth in Complete Auto Transit , and we agree that this is the proper point from which to begin. A state tax will be sustained against a commerce clause challenge, . . . when the tax [1] is applied to an activity with a substantial nexus with the taxing state, [2] is fairly apportioned, [3] does not discriminate against interstate commerce, and [4] is fairly related to the services provided by the State. Complete Auto Transit, 430 U.S. at 279, 97 S.Ct. at 1079. The Court of Appeals summarily conclude[d] that the tax under attack easily satisfies prongs (1), (2), and (4) of [the] test. We agree. A taxpayer's residence in Kentucky while owning and reaping benefits from the corporate shares provides the substantial nexus required by the first prong of the Complete Auto Transit test. This Court has recognized that the second prong, fairly apportioned, is satisfied by the same factors that satisfy the substantial nexus requirement. Revenue Cabinet v. Budget Rent-A-Car, Ky., 704 S.W.2d 199, 202 (1986). We agree, therefore, in this case the second prong is also satisfied. The fourth prong of the Complete Auto Transit test is also satisfied. The United States Supreme Court has determined that requirement (4) is met [w]hen a tax is assessed in proportion to a taxpayer's activities or presence in a State. Commonwealth Edison Co. v. Montana, 453 U.S. 609, 627, 101 S.Ct. 2946, 2958, 69 L.Ed.2d 884 (1981). The shareholders affected by KRS 132.020 are citizens who derive benefits from Kentucky. Therefore the tax is fairly related to the services provided by the state, because the taxpayer is shouldering its fair share of. . . `the advantages of a civilized society' Commonwealth Edison, 453 U.S. at 627, 101 S.Ct. at 2958, quoting Japan Line, Ltd. v. County of Los Angles, 441 U.S. 434, 445, 99 S.Ct. 1813, 1819-20, 60 L.Ed.2d 336 (1979). We also believe, as did the Court of Appeals, that the third prong requires further analysis. However, we turn to the case of Oregon Waste , which the Court of appeals did not address, to determine the correct standards to be applied in this case. The United States Supreme Court explains in Oregon Waste that the first analytical step in determining whether a statute is unconstitutional under the negative commerce clause principles is to ascertain whether the statute discriminates against interstate commerce or whether the regulation has only incidental effects on interstate commerce. As defined in Oregon Waste , `discrimination' simply means differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter. Oregon Waste, ___ U.S. at ___, 114 S.Ct. at 1350. (emphasis added). We emphasize the language economic interests because while there are no goods crossing state lines here, there are in-state and out-of-state economic interests affected by this legislation. Companies interested in raising capital through the issuance of stock shares are having potential investors' decision-making processes affected by this legislation. Companies paying taxes to the state of Kentucky for 75% or more of their property will become more investment attractive than those companies that do not. Such factors impact commerce and the commerce clause is at issue. We conclude that the statute is discriminatory. Appellee argues that St. Ledger is incorrect when it argues that if a tax is found to be discriminatory on its face, it is per se invalid. Respondent states [e]ven a provision that `clearly discriminates' against interstate commerce can be sustained if the measure is justified on grounds unrelated to economic protectionism. Appellee's brief, p. 31. After carefully reviewing Supreme Court precedent, we recognize that respondent is only partially correct. The actual standard stated by the United States Supreme Court is found in Oregon Waste , at ____, 114 S.Ct. at 1351, and requires that a facially discriminatory statute must be invalidated unless respondents can [also] `sho[w] that it advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives.' quoting New Energy Co. of Indiana v. Limbach, 486 U.S. 269, 278, 108 S.Ct. 1803, 1810, 100 L.Ed.2d 302 (1988). The determination that the statute is discriminatory on its face shifts the burden of proof from appellant being required to show that the burden is clearly excessive in relation to the putative local benefits Pike v. Bruce Church, Inc., 397 U.S. 137, 143, 90 S.Ct. 844, 847, 25 L.Ed.2d 174 (1970), to the respondent as stated above. Further, constitutional validity also requires that the justification for the discrimination must pass the strictest scrutiny. The Court of Appeals held that [b]ased upon the clear and unambiguous language of the general ad valorem tax statute and the exemption statute, . . . the Kentucky ad valorem tax scheme on shares is facially discriminatory against interstate commerce. We agree. The exemption statute effectively discriminates between transactions based upon interstate elements. First, a potential stockholder who is a Kentucky resident and is contemplating investment in a corporation will find the stock in the corporation whose property is primarily (75% or more) located in the state of Kentucky more attractive than that of a corporation whose property is primarily located outside the state. As a result, and at a minimum, the investor has had his investment decision affected by this tax provision. This alone constitutes an interference with interstate commerce. Furthermore, this investment decision inevitably affects interstate commerce by channeling the flow of capital into businesses whose property assets are primarily (75% or more) located in Kentucky. This flow of capital no longer operates under the framework of a free market economy as the drafters of the U.S. Constitution intended. Rather, this change in the manner which Kentucky residents invest funds operates in such a way as to provid[e] a direct commercial advantage to local business. Northwestern States, 358 U.S. at 459, 79 S.Ct. at 362. The effects of this legislation on interstate commerce may be carried a step further by examining its impact on corporate decision making. Companies seeking to attract investors will be encouraged to maintain their property holdings in the state of Kentucky. However, the placement of facilities in this state may not prove to be the most prudent business tactic from a financial or operational perspective, thereby possibly increasing costs of production when these costs could easily have been avoided had the tax regulation not been enacted. As a result of our determination that the exemption statute is discriminatory on its face, the standard articulated in Oregon Waste applies. Therefore, the Revenue Cabinet is required to sho[w] that [the statute] advances a legitimate local purpose that cannot be adequately served by reasonable nondiscriminatory alternatives. New Energy Co. of Indiana v. Limbach, 486 U.S. 269, 278, 108 S.Ct. 1803, 1810, 100 L.Ed.2d 302 (1988). Further, justifications for discriminatory restrictions on commerce [must] pass the `strictest scrutiny.' Oregon Waste, ___ U.S. at ____, 114 S.Ct. at 1351. The Cabinet attempts to persuade this Court that even though the questioned exemption does, on its face, directly or indirectly discriminate against interstate commerce, the statute is constitutionally valid because the tax differential is intended to eliminate double taxation. The Court of Appeals determined that this purpose satisfies constitutional limitations, holding that this is a compensatory tax, as that term is defined in the case of Tyler Pipe Industries, Inc. v. Washington State Department of Revenue, 483 U.S. 232, 107 S.Ct. 2810, 97 L.Ed.2d 199 (1987). Tax statutes have been upheld, even if a burden on interstate commerce, if they effectively compensate for the variance in costs between interstate and intrastate commerce. See Armco, Inc. v. Hardesty, 467 U.S. 638, 104 S.Ct. 2620, 81 L.Ed.2d 540 (1984); Darnell v. Indiana, 226 U.S. 390, 33 S.Ct. 120, 57 L.Ed. 267 (1912); Kidd v. Alabama, 188 U.S. 730, 23 S.Ct. 401, 47 L.Ed. 669 (1903). This Court recognizes that the compensatory tax doctrine is merely a specific way of justifying a facially discriminatory tax as achieving a legitimate local purpose that cannot be achieved through non-discriminatory means. Oregon Waste, ___ U.S. at ____, 114 S.Ct. at 1352. Therefore, we will also undertake a similar analysis. The Court of Appeals, relying on Indiana Department of State Revenue v. Felix, 571 N.E.2d 287, 291 (Ind.1991), citing American Trucking Associations v. Scheiner, 483 U.S. 266, 288, 107 S.Ct. 2829, 2842, 97 L.Ed.2d 226 (1987) (dicta), found that the crucial issues to be determined were whether (1) substantially equivalent and intrastate and interstate events are being taxed, and (2) the tax produces uniform and equitable treatment of interstate and intrastate commerce. The Court of Appeals referred to Darnell and held that the taxing of shares in corporations whose assets are beyond the reach of taxation by this jurisdiction and the assets of property of those corporations who are greatly concentrated within this Commonwealth has a fair and equalizing impact upon interstate and intrastate commerce. It is clear to this Court that Darnell is directly on point and is dispositive. In that case the United States Supreme Court held that taxing the property of domestic corporations and stock of foreign ones . . . is consistent with substantial equality. Darnell, 226 U.S. at 398, 33 S.Ct. at 121. The United States Supreme Court has also held that the taxing of shares in corporations and taxing property of corporations are substantially equivalent events. Kidd v. Alabama, 188 U.S. 730, 731, 23 S.Ct. 401, 402, 47 L.Ed. 669 (1903). Therefore this Court holds that the first prong of this test has been met. Next, we consider whether the tax produces uniform and equitable treatment of interstate and intrastate commerce. Appellant urges this Court to conclude that the exemption statute does not result in equitable treatment by directing us to the cases of American Trucking Assn. v. Scheiner, 483 U.S. 266, 284, 107 S.Ct. 2829, 2840, 97 L.Ed.2d 226 (1987), and Armco Inc. v. Hardesty, 467 U.S. 638, 644, 104 S.Ct. 2620, 2623, 81 L.Ed.2d 540 (1984). We recognize that these cases could lead us to determine that the second prong of this test cannot be satisfied. However, the controlling case of Darnell held that elimination of double taxation was a justifiable and legitimate burden on interstate commerce, and it is this precedent which must control. As a result, we affirm the Court of Appeals as to its holding that the exemption statute is constitutionally valid.