In the latest developments in the continuing saga of New York State’s attempts to collect taxes on reservation sales of cigarettes to non-Indians, a Federal appeals court lifted an injunction that had kept the State from enforcing its regulations for collecting the tax, and the next day a State court entered another injunction. Oneida Nation of New York et al. v. Cuomo, Docket No. 10-4265(L) et al., (2d Cir. May 9, 2011); Seneca Nation of Indians v. State of New York, Index. No. 2011-000714 (Sup. Ct. Erie Cnty. May 10, 2011).

The Seneca Nation of Indians, Unkechauge Indian Nation, St. Regis Mohawk Tribe, Cayuga Indian Nation of New York, and Oneida Nation of New York (referred to by the court collectively as the “tribes”) filed three separate actions in federal court seeking to enjoin the State from enforcing the collection of tax on sales to non-tribal-member purchasers, claiming that the law interferes with tribal sovereignty and fails to ensure their access to tax-free cigarettes for personal use. In two cases, the Western District denied the preliminary injunctions but stayed enforcement pending appeal, while in the third action the Northern District granted a preliminary injunction. The cases were consolidated for an expedited appeal.

The tax at issue is imposed at $4.35 per pack on all non-exempt cigarettes sold in the state. While the tax ultimately falls on the consumer, it is “precollected” from a limited number of license stamping agents, and these agents are the only legal entry point for cigarettes into New York. The agents incorporate the tax into the price charged to distributors and affix stamps to the packs allowing the cigarettes to be legally sold. While federal law prohibits New York from taxing cigarettes sold to enrolled tribal members on their own reservations for personal use, the State’s right to tax sales on reservations to non-tribal members has been upheld by the United States Supreme Court. Dep’t of Taxation & Fin. v. Milhelm Attea & Bros., 512 U.S. 61 (1994). The Department had previously issued regulations attempting to collect tax on the nonexempt portion of sales, but these had been repealed in 1998, and for many years, according to the Second Circuit, the Department had followed a policy of “forbearance” allowing the sale of untaxed cigarettes to continue, in an atmosphere of “litigation, civil unrest, and failed negotiations.” Meanwhile, statistics regarding the numbers of cigarettes sold indicated to the State that significant amounts of tax on nonmember sales, estimated at $110 million per year, were not being collected.

For example, if only Unkechauge members had purchased the entire volume of untaxed cigarettes bought by Unkechauge retailers from licensed agents, every man, woman, and child on the reservation would have smoked 364 packs of cigarettes per day in 2009. Similar figures were presented for the other tribes, and the court accepted the fact that large amounts of cigarette tax were not being paid.

In June 2010, the Department revoked its former “forbearance” policy, the Legislature amended the statute, and the Department adopted new implementing regulations. The new provisions require state-licensed stamping agents to prepay the tax on all cigarettes packs, including those intended for sale to exempt tribal members. Tribes may purchase a limited quantity of untaxed cigarettes, determined to mirror each tribe’s “probable demand,” calculated by analyzing tribal population and per capita smoking statistics. Tribes may also submit evidence of prior consumption, and the tribes did not challenge the Department’s probable demand figures. Two mechanisms were set forth for tribes to obtain taxfree cigarettes: a “coupon system,” under which the Department provides each tribe with a quantity of tax exemption coupons corresponding to probable demand, which allow the tribe to purchase tax-free cigarettes; or the “prior approval” system, which requires wholesalers to obtain the Department’s approval before selling tax-free cigarettes to a tribal government.

The tribes contended that the precollection mechanism either imposes an impermissible direct tax on tribal retailers or, alternatively, imposes on them an undue and unnecessary economic burden. They also contended that the coupon and prior approval systems interfere with their right of self-government, unduly burden tribal retailers, and fail to adequately ensure members’ access to tax-free cigarettes.

The Second Circuit Court of Appeals has now rejected all of these arguments, finding that the tribes could not demonstrate a likelihood of success on the merits, which is necessary for a preliminary injunction. It noted that the United States Supreme Court has held that states may “impose ‘on reservation retailers minimal burdens reasonably tailored to the collection of valid taxes from non-Indians,’” citing Milhelm Attea, and that the Supreme Court had upheld several times the use of collection mechanisms similar to those put in place by New York. The appeals court stated that, while the precollection mechanism would indeed impose an increased economic cost on tribal retailers who continue to market taxable cigarettes to non-member purchasers, those costs result from the retailer’s decision to make such sales, and the court found that the tribes possessed no “vested right” to make a certain volume of sales, or even to make any such sales at all. The court also rejected the tribes’ argument that the substantial difference in tax rates between this case and earlier cases in which states’ collection methods were upheld—which had been in the range of $1.20 to $1.60 per carton, instead of the $43.50 per carton currently imposed by New York — meant the burden was greater and mandated a different result, noting that, to the contrary, the higher the tax rate, the greater the economic incentive to avoid the tax. The court also rejected arguments that implementation issues and problems are sure to arise, stating that such hypothetical worries cannot support a pre-enforcement injunction of the entire collection mechanism.

However, no sooner was the federal injunction lifted than a State court issued a new one. On May 10, a New York State Supreme Court justice issued a temporary restraining order preventing immediate enforcement of the taxes, in response to a claim by the Seneca Nation that the regulations implementing the 2010 amended statute were adopted without proper public input. The temporary restraining order was put in place for three weeks, and the State court is scheduled to hear argument on the validity of the regulations on June 1.

Additional Insights. Disputes over the imposition of cigarette taxes on reservation sales to non-members have been going on for many years in New York, and appear to have only grown in recent years as the tax rate has increased dramatically. Although the Supreme Court held unambiguously in Milhelm Attea that the State had the right to collect such taxes, political and practical issues had never been sufficiently resolved to allow such collections to proceed. For instance, in 1997, portions of the New York State Thruway in upstate New York were blockaded by tribal members challenging cigarette taxes not with injunctions but with violence and burning tires. The Seneca Nation has also reportedly proposed to collect its own tolls on sections of the Thruway that run through reservation land, saying it was rescinding a 1954 agreement that allowed construction of the Thruway on the grounds the agreement had not received proper federal approval. No matter how the new State court challenge is ultimately adjudicated, it is hard to say with confidence that this long-simmering issue is finally headed to resolution.