July 14, 1997
Muriel K. Offerman Secretary of Revenue North Carolina Department of Revenue 501 North Wilmington Street Raleigh, North Carolina 27604
Re:Advisory Opinion: Constitutionality of Subsidiary Deduction for North Carolina
Domiciled Corporations under N.C.G.S. § 105-130.7(4)
Dear Secretary Offerman:
You have requested our opinion regarding the constitutionality of N.C.G.S. § 105-130.7(4) which provides: "A corporation that, at the close of its taxable year, has its commercial domicile within North Carolina shall be allowed to deduct all dividends received from corporations in which it owns more than 50% of the outstanding voting stock."
The question you pose is not new. In Richmond Food Stores, Inc. v. Jones, 22 N.C.App. 272, 206 S.E.2d 346 (1974), the Court of Appeals held that a statutory scheme which effectively imposed a higher rate of tax on nonresident distributors of bottled soft drinks than on resident distributors violated the Commerce Clause of the United States Constitution. The court found the rate differential to be "clearly arbitrary and discriminatory," holding that the lower tax rate and less burdensome method of payment afforded only to resident distributors under an alternative method of payment was discriminatory and an undue burden on interstate commerce. "The implied exclusion of non-resident distributors from the act has the same effect as if [it] were boldly stated in express terms and is equally noxious to the Constitution of the United States. It is void." Id. at 275, 206 S.E.2d at 348.
The Commerce Clause of the United States Constitution ("Commerce Clause"), n1 phrased as an affirmative grant of regulatory power to Congress, has long been interpreted as containing a negative aspect which denies states the power to interfere with the free flow of commerce. See Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 458 (1959). In its negative aspect, the Commerce Clause "prohibits economic protectionism–that is, ‘regulatory measures designed to benefit in-state economic interests by burdening out-of-state competitors.’" Fulton Corp. v. Faulkner, 511 U.S. —, —, 133 L.Ed.2d 796, 804 (1996) (quoting New Energy Co. of Indiana v. Limbach, 486 U.S. 269, 273-274 (1988)).
n1 "The congress shall have power … to regulate commerce with foreign nations, and among the several states, and with the Indian tribes…." U.S.Const. Art. I, § 8.
The United States Supreme Court has held that the first step in analyzing any law subject to judicial scrutiny under the negative Commerce Clause is to determine whether it "regulates evenhandedly with only incidental effects on interstate commerce, or discriminates against interstate commerce." Oregon Waste Systems v. Department of Environmental Quality, 511 U.S.
—, —, 128 L.Ed.2d 13, 21 (1994). For these purposes, "’discrimination’ simply means differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter." Id. "State laws discriminating on their face are ‘virtually per se invalid.’" Fulton, 511 U.S. at —, 133 L.Ed.2d at 805 (quoting Oregon Waste Systems, 511 U.S. at —, 128 L.Ed.2d at 21)).
A fundamental principle under the Commerce Clause is that "no state may, consistent with the Commerce Clause, ‘impose a tax which discriminates against interstate commerce … by providing a direct commercial advantage to local businesses.’" Boston Stock Exchange v. State Tax Commission, 429 U.S. 318, 329 (1977) (quoting Northwestern States Portland Cement Co.
v. Minnesota, 358 U.S. at 458). "A state tax that favors in-state businesses over out-of-state businesses for no other reason than the location of its business is prohibited by the Commerce Clause." American Trucking Associations v. Scheiner, 484 U.S. 266, 286 (1987). Similarly, in Kraft General Foods, Inc. v. Iowa Department of Revenue, 505 U.S. 71 (1992), the United States Supreme Court held that a statute that treated dividends received from foreign (international) subsidiaries less favorably than those received from domestic subsidiaries facially discriminated against foreign commerce in violation of the Foreign Commerce Clause.
In Delta Air Lines, Inc. v. Department of Revenue, 455 So.2d 317 (1984), the Florida Supreme Court held that a tax credit granted to only Florida-based carriers violated the Commerce Clause because the credit provided a direct commercial advantage to Florida-based common carriers over non-Florida-based carriers. The court found that the credit provision conferred an artificial economic advantage on those interstate air carriers who maintained their corporate headquarters in Florida over those competing air carriers who based their corporate headquarters outside the state.
In Perini Corporation v. Commissioner of Revenue, 419 Mass. 763, 647 N.E.2d 52 (1995), the Massachusetts Supreme Court held that a corporate excise tax provision allowing a domestic parent corporation to deduct from its taxable net worth the value of a subsidiary of which it owned 80% or more voting stock, but only if that subsidiary is incorporated in the state, facially discriminated against interstate commerce since the provision drew a distinction solely on the basis of the commercial domicile of the subsidiary and treated a domestic corporation more favorably if it chose to acquire a domestic rather than foreign subsidiary.
Recently, the United States Supreme Court ruled that the taxable percentage deduction of North Carolina’s intangibles tax facially discriminated against interstate commerce in violation of the Commerce Clause, failed justification as a valid compensatory tax and therefore could not stand. Fulton Corp. v. Faulkner, 511 U.S. —, 133 L.Ed.2d 796. In the wake of Fulton, the various tax preferences in N.C.G.S. § 105-130.7 and other similar provisions received close scrutiny.
In its recommendations to the General Assembly, the Corporate Tax Division, based in part on informal discussions with the Attorney General’s Office, recommended repeal of subsection (4) of N.C.G.S. § 105-130.7, along with subsections (1), (2), (3a) and (5). The Report of the Revenue Laws Study Committee to the Legislative Research Commission recommended repeal of subsections (1), (2), (3a) and (5). The Report further recommended amending subsection (4) to extend the deduction to all corporations, regardless of state of commercial domicile and limiting the deduction to the net amount, i.e., disallowing the deduction of expenses relating to the untaxed income. The General Assembly repealed subsections (1), (2), (3a) and (5). 1996 N.C.Sess.Laws (Second Extra Sess.) c. 14, s. 3. The legislature took no action regarding subsection (4), however.
The deduction afforded by N.C.G.S. § 105-130.7(4) is only available to corporations commercially domiciled in North Carolina. Thus, the provision provides a direct commercial advantage to local businesses, benefiting in-state corporations at the expense of their out-of-state competitors. Moreover, the deduction favors in-state corporations over out-of-state corporations based solely on the location of the taxpayer’s business. The Commerce Clause prohibits such preferential treatment which "’forecloses tax-neutral decisions and … creates … an advantage’ for corporations operating in [North Carolina]…." Westinghouse Electrical Corp. v. Tully, 466 U.S. 388, 406 (1984) (quoting Boston Stock Exchange, 429 U.S. at 331). See also Oregon Waste Systems v. Department of Environmental Quality, 511 U.S. —, 128 L.Ed.2d 13; New Energy Co. of Indiana v. Limbach, 486 U.S. 269; American Trucking Associations v. Scheiner, 484 U.S. 266; Boston Stock Exchange v. State Tax Commission, 429 U.S. 318. It is therefore our opinion that N.C.G.S. § 105-130.7(4) facially discriminates against interstate commerce in violation of the Commerce Clause and would not survive a judicial challenge. n2
n2 We do not believe N.C.G.S. § 105-130.7(4) can be justified as a valid compensatory tax under Fulton.
We hope the foregoing is helpful. If we can be of further assistance, please let us know.
Sincerely yours,
Reginald L. Watkins Senior Deputy Attorney General
Kay Linn Miller Hobart Assistant Attorney General