Senator John H. Kerr, III Post Office Box 1616 Goldsboro, North Carolina 27533-1616
Re: Advisory opinion; constitutionality of additional 1% tax upon gain derived from the sale of stocks, mutual funds, bonds and other evidences of debt; North Carolina Constitution, Art. I, Sec.
Dear Senator Kerr:
You request our opinion as to the constitutionality of legislation expected to be introduced in the forth coming 1994 Regular Session. As outlined, a bill would repeal the existing intangibles tax upon stock, mutual funds, bonds and related evidences of debt and substitute an additional 1% tax upon capital gain derived from the sale of this property. These intangibles would be made exempt from ad valorem taxes imposed by The Machinery Act. The legislation would probably be ratified in July or August and apply to taxable years beginning on or after January 1, 1994. You appear to be especially interested in our advice as to any possible impermissible retroactive features of these amendments.
With one possible reservation, we believe a bill drawn along these lines would not offend any federal or state constitutional prohibitions. Analysis under federal law is the easier question. The United State Constitution contains no specific provision barring "retrospective " taxation, such as that found in the North Carolina Constitution. Instead, challenges to a taxing statute’s retroactivity are evaluated upon a "due process" basis. Welch v. Henry, 305 U.S. 134, 146 (1938). Under this standard, retroactive application of a tax to a completed transaction is apparently tolerated until such time that the tax can be said to have become "harsh and oppressive." Id. at 147. In Welch, the Court permitted the State of Wisconsin to impose an income tax in 1935 upon dividends received in 1933.
Other than as noted below, North Carolina already income taxes the gain from the instruments in question. The projected legislation would not create a new and distinct tax upon this property, but would merely increase an existing rate of tax. Such a change would not violate the federal constitution since Nobody has a vested right in the rate of taxation, which may be retroactively changed at the will of Congress at least for periods of less than twelve months; Congress has done so from the outset.
Cohan v. Commissioner, 39 F.2d 540, 545 (2d Cir. 1930). See also Lamb v. Wedgewood South Corp., 308 N.C. 419, 444, 302, S.E.2d 868, 882 (1983) (no person has vested right in the continuance of the common or statute law); State ex rel Banking Comm. v. Citicorp Savings Indus. Bank (proposed), 74 N.C. App. 474, 477, 328, S.E.2d 895, 897 (1985) ("no one has the right for the General Assembly not to change a law").
If enacted in the summer but effective the preceding January, the bill would constitute a mid-year taxation statute, or one which applies to the entire calendar year in which ratification occurs. An unbroken line of federal decisions has sustained mid-year acts against all constitutional The Court consistently has held that the application of an income tax statute to the entire calendar year in which enactment took place does not per se violate the Due Process Clause of the Fifth Amendment.
In accord: United States v. Hudson, 299 U.S. 498, 500 (1937) (no denial of due process to make income tax statute retroactive for relatively short period so as to include profits from transactions consummated while statute being enacted.)
In view of these well-settled principles, we believe the bill as outlined will withstand constitutional challenge at the federal level.
With one possible exception, we are equally confident that the amendments would not violate the North Carolina Constitution, and most particularly, Art. I, Sec. 16’s prohibition against "retrospective" taxation. There is nothing retrospective about this legislation. Income tax statutes address "realized gains and realized losses." Ward v. Clayton, 276 N.C. 411, 416, 172 S.E.2d 531, 535 (1970). North Carolina’s income tax is actually assessed in the calendar year following the taxable year for which the assessment is made. G.S. 105-134.2. A year’s income is treated "as one thing, not made up of several portions or items." Norman v. Bradley, 173 Ga. 482, 160 S.E. 413, 415 (1931). For income tax purposes, the transaction taxable "is the realization of income," and a tax upon income realized after a statute’s effective date "is not retrospective in nature." Herrick v. Lindley, 59 Ohio St. 2d 22, 25, 391 N.E. 2d 729, 732 (1979).
The expected legislation will add items of income to a taxpayer’s annual income stream. Realization of actual gain or profit will not occur until the close of 1994 for a calendar year taxpayer. The preceding authorities satisfy us that a statute merely increasing the rate of taxation upon net income enacted relatively shortly after the events producing gross income does not constitute retrospective taxation forbidden by the North Carolina Constitution.
Our review would not be complete without reference to previously issued state and county debt instruments whose profit the General Assembly has exempted from income taxes. See, e.g., bonds issued by various hospital, medical, housing and port authorities and agencies. G.S. 122A19, 131A-21, 131E-28 and 143B-456. The North Carolina Constitution, Art. V., Sec. 2(19), provides that the power of taxation "shall never be surrendered, suspended or contracted away." Since no one is entitled to a perpetual tax exemption, which could "impoverish the State for all time, " Railroad v. Reid, 64 N.C. 156, 159 (1870), it may be that gain from these prior instrument as well could now be included within the proposed amendments. But then the retrospective taxation question, as well as a possible contract impairment issue, becomes more difficult. Moreover there may be broad fiscal implications regarding the state’s creditworthiness, or general policy considerations, which should be addressed before these special undertakings are expressly brought within the proposed legislation.
We hope you find the foregoing helpful.
Reginald L. Watkins Senior Deputy Attorney General
Special Deputy Attorney General