On August 24, the U.S. District Court for the Northern District of Alabama determined that the imposition of Alabama sales and use taxes on the purchase of diesel fuel by rail carriers did not constitute discriminatory taxes that are specifically prohibited under the Railroad Revitalization and Regulatory Reform Act (4-R Act).¹ The Court rejected the taxpayer's argument that the diesel fuel sales and use tax exemptions available to motor carriers and water carriers made the sales and use taxes imposed on rail carriers "discriminatory." The Court reasoned that when taking into account the excise tax applicable to motor carriers, and not rail carriers, motor carriers paid a "substantially similar" rate of tax, and that the taxpayer failed to show any discriminatory effect with respect to the tax treatment of water carriers.

Background

The taxpayer, a common carrier railroad engaged in interstate commerce, filed suit against the Alabama Department of Revenue, alleging that the imposition of Alabama sales and use taxes on the taxpayer's purchase or consumption of diesel fuel violated the 4-R Act, which prohibits a state or political subdivision from imposing "another tax"² that discriminates against a rail carrier.³ In the suit, the taxpayer sought an injunction prohibiting the Department from collecting the Alabama sales and use taxes on the taxpayer's purchase or consumption of diesel fuel within the state. The taxpayer also sought declaratory judgment that the imposition of these taxes violated the 4-R Act. The U.S. District Court for the Northern District of Alabama dismissed the case subsequent to the Eleventh Circuit's holding, in a different case, that a tax exemption cannot be deemed a discriminatory tax which is prohibited by the 4-R Act.⁴

The taxpayer appealed, but the Eleventh Circuit affirmed the dismissal. As a result, the taxpayer petitioned the U.S. Supreme Court for a writ of certiorari to determine whether a state's exemptions afforded to certain carriers (competitors of rail carriers) can serve as a basis to bring forth a claim that a state has violated the 4-R Act by imposing "another tax that discriminates against a rail carrier." After granting the petition, the Supreme Court reversed the Eleventh Circuit's decision and determined that the taxpayer was permitted to challenge Alabama's sales and use taxes under the 4-R Act.⁵ The Supreme Court remanded the case for further proceedings on the merits. The U.S. District Court for the Northern District of Alabama considered the case on remand.

Alabama's Imposition of Taxes

Under Alabama law, railroads are subject to a 4 percent state-level sales and use tax on their purchases of diesel fuel in the state.⁶ Moreover, local jurisdictions may impose additional sales and use taxes on these purchases.

While the purchases of diesel fuel by railroads are subject to sales and use taxes in Alabama, the purchases of diesel fuel by other carriers, motor carriers or interstate water carriers, are exempt. Motor carriers are subject to a special motor fuels excise tax of 19 cents per gallon on their purchases of diesel fuel rather than the sales and use taxes,⁷ and water carriers are exempt on their purchase of diesel fuel used for interstate or foreign commerce.⁸

Imposition of Taxes Not Discriminatory

The District Court held that the imposition of Alabama sales and use taxes on the purchase of diesel fuel by railroads was not a discriminatory tax under the 4-R Act. In reviewing the purpose of the 4-R Act, the Court noted that Congress had enacted the Act to restore the financial stability of railroads. One of the means by which it expected to accomplish this restoration was the prohibition of a state or local level tax that discriminates against a rail carrier. While Congress desired financial stability for railroads, it did not intend to grant preferential treatment to railroads. Rather, its intention was to create an "even playing field" with other taxpayers. The Court determined that the taxpayer was required to prove the discriminatory effect of the taxes by a preponderance of the evidence.

Comparison Class

In determining whether discrimination existed, the Court explained that it was first required to determine the appropriate "comparison class." The parties agreed that the appropriate comparison class was a rail carrier's competing transportation modes. In addition, other courts that have addressed the issue have compared rail carriers to such competition. Therefore, the Court deemed the appropriate comparison class was carriers that receive an exemption from sales and use taxes on diesel fuel, namely, motor carriers and water carriers.

Consideration of Entire Tax Scheme

Some courts have limited their consideration to sales and use taxes when determining whether these taxes are discriminatory, but the Court considered the entire taxing scheme. While the Fifth Circuit only considered the sales and use taxes of Louisiana in determining the discrimination issue in McNamara,⁹ it did so because the comparison class was too broad to effectuate a proper evaluation of the "entire cumulative nature and effect of the state's tax scheme." The Fifth Circuit found that the comparison class consisted of "other commercial and industrial taxpayers" rather than other non-rail carriers.

Following the Fifth Circuit's decision in McNamara, other courts have relied on McNamara to limit their analyses to sales and use taxes as well.¹⁰ However, these subsequent decisions adopted the competing modes of transportation comparison class, a class that is "drastically" reduced in size than the class before the Fifth Circuit. Although McNamara's progeny did not distinguish McNamara, the present Court did. It refused to follow McNamara based on the conclusion that the class before it did not make the consideration of the state's tax scheme too difficult to entertain.

Furthermore, the Supreme Court's earlier decision in this case suggested that it was appropriate to evaluate Alabama's entire tax scheme by necessitating a review of the "relative position" of both the taxpayer and the comparison class. The Supreme Court had stated that it was necessary to analyze the comparison class in "all relevant respects."

Motor Carriers

Considering Alabama's entire tax system and not limited to sales and use taxes, the Court found that the Department justified its diesel fuel sales and use tax exemption for motor carriers since motor carriers were subject to a fuel excise tax, whereas rail carriers were not. In fact, the Court found that motor carriers actually paid a "higher rate" of tax than the state's 4 percent sales and use taxes on rail carriers. Even when taking into account the local-level sales and use taxes on rail carriers, there were significant periods of time during which the motor carriers were paying more tax per gallon of diesel fuel. Overall, the Court determined that although the rate paid was "not precisely the same," it was "substantially similar."

The Court also rejected the taxpayer's argument that the way in which Alabama spent its tax collections was relevant to the analysis. The taxpayer maintained that the excise tax imposed on motor carriers benefited motor carriers because the revenue was used to maintain the roads and bridges upon which the motor carriers operated, whereas the sales and use taxes imposed on rail carriers did not benefit their infrastructure because they were required to build and maintain their rail network from their own resources. The Court pointed out that this argument did not apply since the rail network was a private network, restricted from public access, while the state must maintain the roads for motor carriers as well as the general public. Furthermore, the Court rejected the taxpayer's argument as the 4-R Act makes no mention of any restrictions on a state's discretionary spending and rail carriers and motor carriers both pay the same sales and use tax rate on raw materials and the same property tax rate.

Water Carriers

Comparing the taxpayer to water carriers, the Court determined that the taxpayer failed to show the discriminatory effects of the sales and use taxes by a preponderance of the evidence. Moreover, intrastate water carriers were subject to the same sales and use taxes as rail carriers (the exemption only applied to interstate water carriers), and it was questionable as to whether elimination of a tax exemption for water carriers would survive commerce clause scrutiny.

As a result, taking into account Alabama's entire tax scheme and the "relative positions" of the taxpayer and the comparison class, the Court concluded that the sales and use taxes imposed on rail carriers on their purchase of diesel fuel were not discriminatory under the 4-R Act, and dismissed the case with prejudice.

Commentary

In reaching its decision, the Court deviated from a line of cases stemming from the Fifth Circuit's narrowing the analysis in 4-R Act tax discrimination cases to only sales and use taxes. While other circuit and district courts found that considering only sales and use taxes was proper, this Court found that a broader approach was required to fairly consider the alleged discriminatory impact of the sales and use taxes on rail carriers. Also, the Court was reluctant to render the exemption for interstate water carriers invalid, suggesting that doing so was not within its realm of authority. Considering the large amount of taxes and history involved in this case, industry interest in the result, and the fact that the District Court did not follow the line of cases from the Fifth Circuit, the taxpayer is likely to appeal this decision. It remains to be seen whether tax discrimination challenges based on the 4-R Act may be taken by the taxpayer, or other similarly situated taxpayers, in other states.

Footnotes

1 CSX Transportation, Inc. v. Alabama Department of Revenue, Civil Action No. 2:08-cv-655-AKK, Aug. 24, 2012. The Railroad Revitalization and Regulatory Reform Act is codified at 49 U.S.C. § 11501.

2 "Another tax" means a tax other than property tax assessed on rail transportation property or ad valorem property tax on rail transportation property.

3 49 U.S.C. § 11501(b)(4).

4 Norfolk S. Ry. Co. v. Alabama Department of Revenue, 550 F.3d 1306 (11th Cir. 2008).

5 CSX Transportation, Inc. v. Alabama Department of Revenue, 131 S. Ct. 1101 (2011).

6 ALA. CODE §§ 40-23-2(1), 40-23-61(a).

7 ALA. CODE §§ 40-17-2(1), 40-17-220(e).

8 ALA. CODE §§ 40-23-4(a)(10), 40-23-62(12).

9 Kansas City S. Ry. v. McNamara, 817 F.2d 368 (5th Cir. 1987).

10 For example, in Burlington N., Santa Fe Ry. v. Lohman, the Eighth Circuit only considered the sales and use taxes of Missouri in determining the discrimination issue; it found that an evaluation of the taxing scheme in its entirety would be "too difficult and expensive." 193 F.3d 984, 985 (8th Cir. 1999).

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