Alabama May Have Dodged a Bullet in 4-R Act Tax Discrimination Case

State & Local Tax Alert: Alabama Edition


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The U.S. District Court for the Northern District of Alabama issued an important ruling last Friday in the ongoing battle between the railroad companies and the State of Alabama regarding whether the differing taxes and exemptions applied to diesel fuel purchased by railroads versus interstate trucking companies and interstate water carriers violates the Railroad Revitalization and Regulatory Reform Act (“4-R Act”), 49 U.S.C. §11501. The district court ruled that they do not. CSX Transportation, Inc. v. Alabama Department of Revenue, No. 2:08-CV-655-AKK (N.D. Ala., Aug. 24, 2012). The ruling affects the entire Alabama business community—not just the railroads and their competitors.

Our readers may recall that the U.S. Supreme Court reversed the 11th Circuit Court of Appeals last year and held that “CSX may challenge Alabama’s sales and use taxes as ‘tax[es] that discriminate against …rail carrier[s]’ under §11501(b)(4).” CSX Transportation, Inc. v. Alabama Department of Revenue, 131 S.Ct. 1101, 1114 (Feb. 22, 2011) (Kagan, J.) However, the majority opinion did not address whether Alabama’s tax structure in fact discriminates against railroads by exempting both interstate motor carriers and water carriers from state and local sales and use taxes on their diesel fuel purchases. The Supreme Court only determined that the interstate motor carrier and water carrier exemptions to Alabama’s generally applicable sales and use tax could violate the 4-R Act’s prohibition on discriminatory taxation.

On remand, the district court rejected a line of cases emanating from the 8th Circuit Court of Appeals that restricted a court’s purview to only sales and use taxes. Judge Abdul Kallon determined that a broader review was required—one that takes into account other taxes levied on the railroad’s competitors but not on the railroads, such as the 19 cents-per-gallon motor fuel excise tax levied on trucking companies.

What many observers believed to be the more likely flaw in the state’s non-discrimination argument, i.e., the dual sales tax and motor fuel tax exemptions afforded interstate water carriers, turned out to be a non-issue with the court. First, the court reminded the parties that the burden of proof is on the plaintiff-railroads to prove discrimination under the 4-R Act. The court found that CSX “offered no evidence at trial regarding the purported discriminatory effects as it relates to water carriers.” Id. at 31. Then, in a twist, the judge scolded CSX for asking the court to “assume that eliminating Alabama’s diesel tax exemptions for interstate/foreign water carriers would survive commerce clause scrutiny… The court refuses to engage in this advisory speculation…” Id. “Upon review [if the exemption were repealed], a court may find that such taxation impermissibly burdens interstate and international commerce thereby re-requiring the exemption for these water carriers.” Id. at 32. The court ended its analysis by summarily ruling that CSX’s argument that rail carriers and interstate/foreign water carriers are similarly situated in all relevant respects was “too speculative…” Id.

It is unknown whether CSX will appeal this ruling, but we doubt that the railroads will simply walk away at this point. Many Alabama tax practitioners and certain legislators would have experienced déjà vu all over again (in the words of the late great Yogi Berra) if the railroads had been successful. And that of course hasn’t yet been finally determined. Older heads may recall the legislative and fiscal angst brought on by the U.S. Supreme Court’s landmark ruling invalidating the Alabama corporate franchise tax. South Central Bell Tel. Co. v. Alabama, 526 U.S. 160 (1999). It actually took two legislative sessions, one in 1999 and another in 2001—to enact a less punitive and more balanced replacement tax (known as the business privilege tax), and to increase the tax rates associated with the corporate income tax and financial institution excise tax—in order to offset the revenue lost from the repeal of the franchise tax and corresponding shares tax. If an appeals court were to eventually rule that the tax exemption scheme now in place violates the 4-R Act, then refunds would presumably be in order, but more importantly, the legislature would be called on to step in (again) and remedy the problem on a going-forward basis.

Many Republican legislators as well as Governor Bentley have taken a “no new taxes” pledge, which would make any sort of broad-based tax reform effort politically improbable. And enacting industry-targeted taxes, or repealing industry-targeted tax exemptions, would not enjoy much popularity either, and might even create another set of legal problems. Thus, one could almost hear a collective sigh of relief coming from Montgomery when the district court’s ruling was issued last Friday. But the play may not be over quite yet.

Note: Judge Kallon was a longstanding partner in our law firm before going on the bench in 2010