On December 9, the U.S. Supreme Court heard oral arguments in the last of three state and local tax cases that it accepted this term – Alabama Department of Revenue v. CSX Transportation, Inc. (CSX II), a case that had previously been before the Supreme Court. CSX Transportation, Inc. v. Alabama Department of Revenue, 562 U.S. 277 (2011) (CSX I). In CSX II, the Court was asked to determine whether Alabama’s taxation of railroads violated the Railroad Revitalization and Regulatory Reform Act of 1974 (4-R Act), 49 U.S.C. § 11501, by taxing railroads, but not their competitors, on their purchases or use of diesel fuel.

Background

Alabama imposes a 4% sales/use tax on railroads’ purchases or use of diesel fuel in the state; it does not charge the same sales/use tax on the diesel fuel purchases of motor carriers or water carriers. Ala. Code §§ 40-23-2(1); 40-17-325(B). However, motor carriers pay a $0.19 per gallon excise tax on their purchases of diesel fuel, a tax that rail carriers do not pay. Ala. Code § 40-17-141; 40-17-329(A)(3). Water carriers pay the same sales/use tax as railroads for diesel fuel used for intrastate transportation but pay no tax (sales/use or excise) for fuel used for intrastate transportation. Ala. Code § 40-23-4(a)(10).

In 2008, CSX Transportation, Inc. (CSX) sued the Alabama Department of Revenue (Department) claiming that its sales/use tax discriminated against railroads in violation of the 4-R Act. At issue in the case was subsection (b)(4) of the 4-R Act, the “catchall” provision, which prohibits a state from “impos[ing]another tax that discriminates against a rail carrier.” (Emphasis added). CSX argued that the sales/use tax was discriminatory because rail carriers were required to pay the tax on their purchases or use of diesel fuel while their competitors were exempt from the tax.

CSX I

The first trip to the Supreme Court addressed whether the catchall provision could be used to challenge a sales tax exemption. In CSX I, Justice Elena Kagen authored the majority opinion holding that the catchall provision enables a railroad to challenge a sales tax exemption as discriminatory and remanding the case for a determination of whether discrimination existed under Alabama’s fuel taxing scheme. Justices Clarence Thomas and Ruth Bader Ginsburg dissented from that opinion on the grounds that a tax exemption scheme is discriminatory only if it targets or singles out railroads by comparison to other commercial and industrial taxpayers.

CSX II

On remand, the district court held a bench trial and the parties stipulated that the railroads’ principal competitors in the area of transportation of interstate commerce in Alabama are motor carriers and interstate water carriers. Using the stipulated comparison class, the district court found that the sales/use tax exemption did not amount to a discriminatory tax under subsection (b)(4). With respect to motor carriers, the court explained that motor carriers were subject to a comparable fuel excise tax because, during the tax years at issue (2007-2009), rail carriers and motor carriers paid “substantially similar” rates per gallon of diesel fuel. As for water carriers, the district court found no discrimination because, among other things, CSX had failed to prove a discriminatory effect.

The Eleventh Circuit reversed, holding that because CSX’s competitors do not pay the sales/use tax on their purchases or use of diesel fuel, CSX had established a prima facie case of discrimination, and the burden shifted to the Department to justify its discriminatory tax. The Eleventh Circuit explained that, contrary to the Department’s argument, the facial discrimination could not be justified by the fuel excise tax. Declining to undertake the “Sisyphean burden” of evaluating the fairness of Alabama’s tax scheme, the court explained that the evaluation of discrimination under subsection (b)(4) should focus on examining only the challenged tax and without regard to other aspects of the state’s taxing scheme.

The U.S. Supreme Court granted certiorari in CSX II and asked the parties to brief and argue two questions, the second of which was raised by the U.S. Solicitor General:

  1. Whether a state “discriminates against a rail carrier” in violation of 49 U.S.C. § 11501(b)(4) when the State generally requires commercial and industrial businesses, including rail carriers, to pay a sales and use tax but grants exemptions from the tax to the railroads’ competitors; and
  2. Whether, in resolving a claim of unlawful tax discrimination under 49 U.S.C. § 11501(b)(4), a court should consider other aspects of the State’s tax scheme rather than focusing on the challenged tax provision.

Summary of Oral Argument

Comparison Class

The Alabama Solicitor General argued that the comparison class under the catchall provision should include all general commercial and industrial taxpayers (nearly all of which pay sales/use tax on fuel purchases) because that is the comparison class for purposes of other sections of the 4-R Act. Justices Antonin Scalia and Kagan questioned the Department’s assertion pointing out that the language of these provisions and the Court’s holding in CSX I demonstrate that the catchall language is very different from the other provisions.

The Assistant U.S. Solicitor General and CSX both argued that the comparison class in this case should only be comprised of CSX’s competitors.

The Justices repeatedly asked questions relating to whether water carriers were CSX’s direct competitors. CSX pointed out that the parties stipulated that water carriers were a major competitor of the railroads while the Department noted that this stipulation was limited to the intrastate market.

Sutherland Observation: There is a circuit court split on the issue of the composition of the comparison class with regard to discriminatory actions under the catchall that could be resolved by the Court.

Discrimination

Both the Alabama Solicitor General and the Assistant U.S. Solicitor General took the position that, even if the narrower “competitor” comparison class is used, the state should be allowed to offer justification for treating rail carriers differently than their competitors. In their view, the sales/use tax on diesel fuel and the fuel excise tax on motor carriers are roughly equivalent and, therefore, Alabama’s sales tax is not discriminatory. Justice Sonia Sotomayor questioned the Department on whether it was simply “fortuitous” that such tax burdens were equivalent during 2007-2009 and whether that could change at some point.

The Assistant U.S. Solicitor General acknowledged the narrow scope of the compensatory tax doctrine under the dormant Commerce Clause. Nevertheless, she believed the sales tax on railroads and the excise tax on motor carriers were comparable, as the district court had found. As for water carriers, she said that issue should be remanded back to the Eleventh Circuit because it did not address the district court’s holding that there was no discrimination with respect to the water carriers.

CSX argued that the comparability analysis performed by the district court with respect to the motor carriers and proposed by the Department and the Assistant U.S. Solicitor General is overly simplified in light of the different taxes imposed on different activities at different rates and for different purposes. Justice Stephen Breyer agreed that “state taxes are so complex.” Although he expressed a concern that the Eleventh Circuit declined to conduct any examination of the nature of the excise tax and its purpose, Justice Breyer acknowledged apprehension determining such a standard, noting that “[w]e’re going to have to tell them [the Eleventh Circuit] just what to do, which that sounds worse to me, and – and, moreover, it may come back here again.”

Sutherland Observation: In its initial briefings, Alabama advanced numerous theories to justify the facially discriminatory nature of using the Alabama sales tax with the excise tax. The state urged the Court to adopt the compensatory tax doctrine or the “rational basis” standard of the Equal Protection Clause. In its reply brief to the Court, the state appears to have shifted its view away from the compensatory tax doctrine, asking to justify treating railroads differently “based on something like a rational basis.” The compensatory tax doctrine is a feature of the dormant Commerce Clause which is implicated when Congress has not affirmatively exercised its powers under the Commerce Clause. However, where Congress has affirmatively spoken under its Commerce Clause powers, as it has under the 4-R Act, the dormant Commerce Clause generally has no application.

Sutherland Observation: In the context of other federal non-discrimination statutes similar to the 4-R Act, the U.S. Supreme Court and courts around the country have refused to consider the cumulative effect of taxes imposed by distinct taxing entities within a state, other than the challenged tax, as justification for facially discriminatory taxes. See, e.g., Arizona Pub. Service Com. v. Snead, 441 U.S. 141 (1979) (considering the Electricity Act, 15 U.S.C. § 391); ABF Freight System, Inc. v. Tax Div. of Arkansas Pub. Serv. Comm’n.,787 F.2d 292, 298 (8th Cir. 1986) (considering the Motor Carriers Act, 49 U.S.C. § 14502); Performance Marketing Ass’n v. Hamer, 998 N.E.2d 54 (Ill. 2013) (considering the Internet Tax Freedom Act, 47 U.S.C. § 151 note).

A ruling in this lengthy seven-year litigation is expected next year and may have a significant impact on similar cases pending in other states, such as Tennessee.