Eleventh Circuit Rules Alabama’s Sales Tax on Railroads Violates 4R Act; What’s Next?

State & Local Tax Alert: Alabama Edition

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In the latest decision in the ongoing saga between CSX and the Alabama Department of Revenue (“ADOR”), the Eleventh Circuit U.S. Court of Appeals ruled that Alabama’s imposition of sales tax on diesel fuel purchases by railroads, but not on diesel fuel used by interstate motor carriers or barge lines, is discriminatory and violates the Railroad Revitalization and Regulatory Reform Act (the “4R Act”), 49 U.S.C. § 11501. CSX Transportation, Inc. v. Alabama Department of Revenue, No. 12-14611 Doc. No. 2:08-cv-00655-AKK (11th Cir. Jul. 1, 2013). This is a significant win for CSX and other railroads operating in Alabama. While it is unclear what the State’s next move will be, it appears that the ADOR has three options: (1) apply for a writ of certiorari to the U.S. Supreme Court; (2) stop collecting the sales tax on railroads but seek a legislative fix to fill the fiscal hole resulting from the lost revenue and to equalize the tax burden borne by the different modes of interstate transportation; or (3) simply stop collecting the sales tax on railroads and let the state’s Education Trust Fund take the revenue “hit,” leaving the railroads with a competitive advantage since their major competitors pay a motor fuel excise tax on their diesel fuel, in lieu of sales tax.

On appeal from the district court, the Eleventh Circuit held, in a 2-1 decision, that Alabama’s sales and use tax indeed discriminates against railroads in violation of the 4R Act and that the ADOR failed to provide a “sufficient justification” for exempting CSX’s competitors from the tax. The Eleventh Circuit adopted a narrow view, one that looks only at the alleged discriminatory tax itself. Thus, the court only looked at whether Alabama’s sales and use tax was discriminatory under the 4R Act, not whether the entire taxing scheme, taking into account exemptions and other taxes levied on the major competitors and not the railroads, was discriminatory toward CSX.

Finding that CSX’s major competitors did not pay Alabama sales/use tax on diesel fuel purchases, the court held that CSX had established a prima facie case of discrimination. This finding shifted the burden of proof to the ADOR to provide a sufficient justification for the differing tax treatment.

Attempting to justify the sales tax exemption enjoyed by CSX’s major competitors, the ADOR tried to show that CSX and its major competitors have roughly equivalent tax burdens when the entire taxing system is taken into consideration. The court rejected that argument, agreeing with the Eighth Circuit’s decision in Union Pacific Railroad Company v. Minnesota Department of Revenue that courts should “look only at the sales and use tax with respect to fuel to see if discrimination has occurred.” This narrower approach was adopted to avoid the “Sisyphean burden of evaluating the fairness of the State’s overall tax structure in order to determine whether a single tax exemption causes a state’s sales tax to be discriminatory.” After the court decided to look only at whether Alabama’s sales and use tax is discriminatory as to CSX, the court said its decision became “much simpler.” CSX pays the State’s sales tax on diesel fuel and its competitors, motor and water carriers, do not. Thus, the court held that the ADOR’s claim that Alabama’s tax code would “ultimately level the playing field” was not a sufficient justification for exempting CSX’s competitors from the sales and use tax on diesel fuel.

It is not known whether the ADOR will seek certioriari (due to the 2-1 ruling here and uncertainty among the circuit courts of appeal) or if it will accept the court’s decision and stop collecting the sales tax on CSX and other railroads. If they adopt the latter approach, not only will this ruling likely force the ADOR to issue refunds to railroad companies that have been paying the discriminatory sales/use tax, the Alabama Legislature may elect to step in, probably next Spring, to remedy the problem on a going-forward basis.

© July 2013. Bruce P. Ely/J. Sims Rhyne, III/Bradley Arant Boult Cummings LLP. This is an excerpt from the authors’ upcoming article of the same title in the Journal of Multistate Taxation and Incentives.