On November 10, 2010, the U.S. Supreme Court (“Court”) heard oral argument in the case of CSX Transportation, Inc. v. Alabama Department of Revenue. At issue in the case is whether “a State’s exemptions of rail carrier competitors, but not rail carriers, from generally applicable sales and use taxes on fuel subject the taxes to challenge” as prohibited discrimination under the Railroad Revitalization and Regulatory Reform Act (“4-R Act”). The lower courts are currently divided on this issue.
While some circuits have held that exemptions from generally applicable non-property taxes may give rise to a claim under the 4-R Act, others have disagreed. The lower courts are also split on which class of taxpayers’ tax treatment should be compared to the treatment of railroads in determining whether a non-property tax discriminates against railroads. Certain circuits have adopted a competitor comparison class for non-property tax claims, comparing the tax treatment of railroads to that of their primary competitors. The remaining circuits that have decided the issue compare the tax treatment of railroads to that of the general mass of commercial and industrial taxpayers, the comparison class required by the 4-R Act to be applied to property tax challenges.
The instant case commenced with CSX Transportation (“CSX”) filing a motion for a preliminary injunction against the Alabama Department of Revenue (“Department”), claiming that the state’s imposition of sales and use taxes on diesel fuel purchased by the railroad while exempting motor carriers and interstate water carriers, the railroad’s primary competitors, constituted discrimination under the 4-R Act. Pending trial, the U.S. District Court for the Northern District of Alabama (“District Court”) initially enjoined the Department from collecting these taxes. However, following the Eleventh Circuit’s decision in Norfolk Southern Railway Company v. Alabama Department of Revenue, which held that sales and use taxes may not be challenged under the 4-R Act based on the grant of exemptions to taxpayers other than railroads, the District Court dissolved the injunction and dismissed the case. CSX appealed, and the Eleventh Circuit affirmed.
During last week’s oral argument, both parties pressed the Court to narrowly construe the issue before it. Responding to some incisive questioning by Justice Ginsburg on the issue of the appropriate comparison class in non-property tax cases, Carter Phillips, Counsel of Record for CSX, maintained that this issue was not before the Court. During this exchange, Justice Ginsburg stated it to be her understanding that the 4-R Act was intended to protect railroads from unfavorable tax treatment vis-à-vis in-state taxpayers, a policy not advanced by the use of a comparison class consisting of a railroad’s interstate carrier competitors. Mr. Phillips urged in response that the Court limit its determination to whether exemptions from non-property taxes may ever subject such taxes to challenge under the 4-R Act. The Department similarly urged a narrow ruling. As asserted by Solicitor General Corey Maze, the issue of when, if ever, the grant of nominal exemptions from a non-property tax could give rise to a challenge under the 4-R Act was not before the Court. According to Mr. Maze, this conclusion followed from the fact that the parties’ characterization of the challenged taxes as “generally applicable” was dispositive of the discrimination issue because, under Department of Revenue v. ACF Industries, Inc. ("ACF Industries"), a tax that is “generally applicable” is, as a matter of law, never discriminatory. Although a literal reading of ACF Industries provides some support for this argument, the Court appeared unwilling to attribute the legal meaning of “generally applicable” suggested in ACF Industries to Alabama’s challenged sales and use taxes based merely on the wording of the parties’ pleadings.
If the Court does narrowly construe the issue before it in handing down its decision, there are two outcomes that seem most likely to emerge. If the Court limits its decision to whether the holding of ACF Industries that exemptions from generally applicable property taxes may not subject such taxes to challenge under the 4-R Act applies to non-property tax challenges, the Court seems likely to hold that this same rule does apply. During oral argument, Justice Kennedy appeared hostile to the notion that a rule different from that applied to property tax challenges should apply to non-property tax challenges. In those circuits that have not extended the holding of ACF Industries to non-property tax challenges, such an extension of that holding by the Court would make it much more difficult for railroads to prevail in future claims similar to that made by CSX.
If, as CSX has insisted, the Court limits its decision to whether exemptions from a non-property tax may ever subject such a tax to challenge under the 4-R Act, there is a good possibility that the Court will hold that such exemptions may in some circumstances give rise to a 4-R Act claim. Chief Justice Roberts and Justices Sotomayor, Alito, Breyer, and Kennedy all acknowledged that at some point a state may carve out exemptions from a tax so extensively that it is effectively reduced to one imposed principally upon railroads, thus singling them out for discriminatory tax treatment. If the Court does limit its decision to holding that in some undefined instances exemptions from a non-property tax may give rise to a 4-R Act claim, this would leave the lower courts with ample discretion to determine when exemptions may discriminate against railroads. Such a ruling would open up new opportunities for railroads to challenge discriminatory taxes, particularly in those circuits that have ruled exemptions to be beyond the reach of the 4-R Act.
Despite the parties’ respective pleas for a narrow ruling in this case, the Court seems disposed to broadly construe the issue presented. ACF Industries appears to supply adequate flexibility for the Court to do so. In ACF Industries, the Court left open the possibility that nominal exemptions from taxes could subject such taxes to challenge under the 4-R Act where the exemption scheme produces the same substantive effect as affirmative discrimination. According to the Court, such a tax could not properly be characterized as “generally applicable.” During oral argument, Justice Kennedy appeared particularly willing to reopen this line of inquiry.1
In light of the Justices’ statements during oral argument, it seems possible that the Court will, while extending the holding of ACF Industries to non-property tax challenges, promulgate a test for determining whether a tax is not properly characterized as “generally applicable,” and thus challengeable as discriminatory based on its grant of exemptions. During oral argument, neither party articulated such a test, and none of the Justices provided any indication of what such a test might look like, except to acknowledge that such an inquiry would be particularly fact-specific. If the Court adopts a facts and circumstances test to determine whether a tax is “generally applicable,” this would, again, leave the lower courts with substantial discretion to determine when exemptions may have the effect of discriminating against railroads.
Of course, if the Court were to limit its decision to adopting a test to determine what taxes are “generally applicable,” it would be leaving its work only half done. Without declaring the appropriate comparison class for evaluating non-property tax discrimination claims, the Court would be leaving the circuit split on this issue intact, preserving the lower courts’ disparate application of the 4-R Act in this area. If in its decision the Court does rule on the appropriate comparison class, this ruling will have significant implications for future claims. All of the Justices who addressed the issue during oral argument seemed to disfavor the use of a competitor comparison class in evaluating non-property tax 4-R Act claims. If the Court rejects the use of a competitor comparison class and holds that the commercial and industrial business comparison class applied to property tax claims must be used in analyzing challenges to non-property taxes, the chances of rail carriers prevailing in future claims similar to that presented by CSX will be significantly diminished.
1Of note, Justice Kennedy delivered the Court’s majority opinion in ACF Industries. Justices Scalia, Thomas, and Ginsburg, the only currently sitting Justices serving on the Court at the time the case was decided, joined in this opinion.