United States: Ninth Circuit Nixes Tax Avoidance Strategy

Last Updated: August 20 2008
Article by Nancy J. Appleby

In a unanimous decision, the U.S. Ninth Circuit Court of Appeals has held that a tribe cannot protect non-Indian contractors from state taxation. The decision sends a clear signal to businesses contracting with tribes that they must pay state sales and use taxes, even if all of their work is on Indian land.

It is well established that tribes are exempt from state sales taxes. However, tribes cannot bestow the benefit of their exemption on non-Indian contractors.

The Barona Band of Mission Indians contracted for a $75 million expansion of its casino. The work was to be done under a lump sum contract with a general contractor, who, in turn, awarded subcontracts for various stages of construction. The tribe "touted" to its contractor a method devised by the tribe to "circumvent " sales tax due to the state of California from the project contractor and subcontractors and set out in the construction contract detailed steps necessary for the contractor and the subcontractors to enjoy tax-free construction work. The contractor and subcontractors were designated as "purchasing agents" for the tribe. All materials had to be delivered on tribal land. Material sales reputedly were not complete until delivery to the tribe's property. All shipping orders and delivery receipts had to include language to the effect that sales were not complete until delivery was accepted on tribal land. The contractor and subcontractors were not allowed to pay for materials in advance.

California assessed the project's electrical subcontractor more than $200,000 in sales tax. Acting on its promise to indemnify and defend the contractor against any tax assessment by the state of California, the Tribe sought a judicial determination that the state sales tax was invalid. Reversing the District Court, the Ninth Circuit viewed the "blueprint" devised by the Tribe very critically, characterizing it as causing "theoretical" sales on Indian land and as an attempted "end-run" that would provide a tax shelter for non-Indian businesses.

In Barona Band of Mission Indians v. Yee, 528 F.3d 1184 (9th Cir. 2008), the court acknowledged that the tribe is exempt from state tax and that the exemption derived from the tribe's sovereignty and the tribe's interest in maintaining its territorial autonomy. However, the court found that the tribe's "right of territorial autonomy is significantly compromised by the tribe's invitation to the non-Indian subcontractor to theoretically consummate purchases on its tribal land for the sole purpose of receiving preferential tax treatment." Additionally, the subcontractor bore the legal responsibility for the state tax. The fact that the subcontractor had the right to pass the tax along to the tribe as part of the contract price – putting the economic burden on the tribe -- did not sway the court. Neither the tribe's exemption nor its sovereignty was impaired. The court was particularly piqued by "sophisticated parties" contracting to create a taxable event on Indian territory that otherwise would have occurred on non-Indian land but for the contract and attempted to "rig" a commercial activity to trigger a tax exemption.

Barona Band is an emphatic reminder that states can impose taxes on the sale of non-Indian products to non-Indians and that federal courts disfavor tribal "manipulation" of tax policy to gain "an artificial competitive advantage over all other businesses in a state."

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