On September 2, 2008, the Court of Appeals for Franklin County issued an opinion in which it ruled that the commercial activity tax ("CAT") is an excise tax that is imposed upon individual transactions. As a result, the Court of Appeals ruled that the CAT, as applied to gross receipts derived from the sale of food for consumption off the premises where sold, violated the provisions of the Ohio constitution prohibiting excise taxes on such transactions. Ohio Grocers Association v. Wilkins, Franklin App. No. 07AP-813, 2008-Ohio-4420. Full text of the Court of Appeals decision.
Background. As part of a comprehensive reform of Ohio's tax system in 2005, the CAT was enacted as a source of replacement revenue for other taxes that were being reduced or phased out. The CAT is imposed upon the privilege of doing business and is measured by taxable gross receipts. R.C. 5751.02. "Taxable gross receipts" are receipts from commercial activity in Ohio, including sales of tangible personal property and the performance of services. R.C. 5751.01(), 5751.03. The CAT is imposed at a flat rate of $150 on persons with annual taxable gross receipts between $150,000 and $1 million. When fully phased in, it will be imposed at a rate of 0.26% on annual taxable gross receipts in excess of $1 million.
Section 3(C), Article XII of the Ohio Constitution, prohibits the imposition of excises taxes upon the sale or purchase or food for human consumption off the premises where sold. Section 13, Article XII, further precludes the imposition of excise taxes upon sales of food, food ingredients, and packaging for food.
Plaintiffs transact sales of food and food ingredients and packaging. They filed an action seeking a declaration that the CAT impermissibly imposed an excise tax on sales of food, ingredients, and packaging in violation of Sections 3(C) and 13 of Article XII. Then-tax commissioner Wilkins and the Department of Taxation responded, claiming that while it is an excise tax, the CAT is imposed upon the privilege of doing business, not on the sale of food. They asserted that the fact receipts from sales of food were included in the tax base did not convert the CAT into an excise tax impose upon individual sales.
Trial Court Decision. In a decision dated August 24, 2007, the trial court issued its decision in which it agreed with the Tax Commissioner and rejected the Plaintiffs' claim that the CAT was essentially an excise tax on sales. While acknowledging that the CAT was an excise tax, the trial court held that the CAT was truly a tax imposed upon the privilege of doing business. Further, based upon prior decisions of the Ohio Supreme Court, it held that including receipts from the sale of food in the base by which the tax was measured did not turn the tax into an impermissible tax on such sales. Plaintiffs then appealed to the court of appeals. Full text of the Trial Court decision.
Court of Appeals Decision. The Court of Appeals acknowledged that R.C. 5751.02 characterized the CAT as a tax on the privilege of doing business. However, it went on to conclude that it must look beyond the label applied to the tax and determine its nature by its operation.
The Court of Appeals then concluded that when applied to gross receipts, the CAT was a sales or transactional tax. It observed that it was irrelevant whether the gross receipts were taxed transaction by transaction, or in the aggregate over a period of time. Since an excise tax could not be imposed upon individual transactions, neither could an excise tax be imposed upon the aggregate of similar transactions.
The Court of Appeals also made reference to a decision from the Lucas County Court of Appeals, Mosser Const. Co. v. City of Toledo, Lucas App. No. L-07-1060, 2007-Ohio-4910, in which the CAT was held to be a transactions tax that could be recovered by a construction contractor under the express terms of its contract with the City of Toledo.
The Court of Appeals acknowledged the several cases in which the Supreme Court of the United States and the Ohio Supreme Court had ruled that an excise tax imposed upon the privilege of doing business was not a property tax on the underlying property or transaction used to measure the tax. The Court of Appeals distinguished those cases, however, on the basis that in those cases, the property or yield on which the tax was computed was not the sole measure of the tax. Since the CAT is imposed only upon gross receipts, the Court of Appeals concluded the decisions of the Supreme Court did not apply.
Comments. The decision rendered by the Court of Appeals is not entirely unexpected, but its reasoning is shaky and disappointing. In both Mutual Holding Co. v. Limbach (1994), 71 Ohio St. 3d 59, and Bank One Dayton, N.A. v. Limbach (1990), 50 Ohio St. 3d 163, the Ohio Supreme Court rejected claims that a franchise tax was invalid because it included within its measure, property upon which a direct tax was prohibited. Relying on the decision in Werner Mach. Co. v. Dir. of Div. Of Taxation (1956), 350 U.S. 492, the Supreme Court in both cases expressly noted that including property that the state could not tax directly, such as federal bonds or notes, in the computation of the franchise tax did not render the tax invalid. The tax was not a tax on property, but rather was a tax on the privilege of doing business. Including the value of federal bonds, which the state could not tax directly, in the tax base did not turn the tax into an invalid property tax on the bonds.
One difficulty with the reasoning of the Court of Appeals is that, for years, receipts from the sale of food have been included in the net income base of taxpayers that are corporations subject to the corporation franchise tax, and of individual owners of pass-through entities that are subject to the personal income tax. Using the same logic as that employed by the Court of Appeals, if it is permissible to include net receipts from the sale of food in the tax base, it should be permissible to include gross receipts from such sales. After all, the nature of the excise being taxed remains the same: The privilege of doing business, or of receiving income, in Ohio.
Attempting to distinguish those cases and the well-settled law they embody on the basis that there was an alternative basis for the tax not only seems to be a stretch, but with respect to Bank One Dayton, the assertion is simply wrong. In that case, the franchise tax in question was imposed upon a single base, that being the net worth of the taxpayer. Insurance companies and financial institutions were and are not subject to an alternate tax base. While the taxpayer in Mutual Holding Co. was subject to the general franchise tax, which is computed on two alternative bases, the prohibition in question related to its parent insurance company, which was taxed only on its net worth. Thus, the basis for distinguishing those decisions seems to rest on a very slender reed at best.
An appeal of the decision is expected, and while acceptance of the appeal is discretionary, the Ohio Supreme Court is going to have to resolve the issue at some point.