United States: Ohio Franchise Tax Investment Credit Declared Unconstitutional

The United States Court of Appeals for the Sixth Circuit found the franchise tax credit granted by R.C. 5733.33(B)(1) unconstitutional because it violated the Commerce Clause of the United States Constitution, Art. I, § 8, cl. 3. At the same time, the September 2, 2004, decision in Cuno v. DaimlerChrysler, Inc., No. 01-3960, 2004 U.S. App. LEXIS 18550, the Court of Appeals upheld Ohio’s Enterprise Zone personal property tax exemption found in R.C. 5709.62 and R.C. 5709.631 against constitutional challenges under the Commerce Clause.

In 1998, DaimlerChrysler entered into an agreement with the city of Toledo, Ohio, to build a $1.2 billion new vehicle assembly plant near its existing Toledo plant, in exchange for various state tax incentives estimated to total $280 million. The plaintiffs challenged both the franchise tax investment credit and the ten year 75% personal property tax abatement for machinery and equipment "first used in business at the project site" pursuant to R.C. 5709.62(C)(1)(a).

The federal district court upheld both Ohio tax incentives. On appeal, the Court of Appeals reversed the decision concerning the franchise tax credit but affirmed the remainder of the District Court’s rationale and decision.

The threshold inquiry was whether the franchise tax credit discriminated against interstate commerce under the United States Supreme Court’s decision in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 279 (1999). In that seminal case, the Court held that a state tax passed Commerce Clause scrutiny if:

1. the activity taxed has a substantial nexus with the taxing state;
2. the tax is fairly apportioned to reflect the degree of activity that occurs within the state;
3. the tax does not discriminate against interstate commerce; and
4. the tax is fairly related to benefits provided by the state.

The plaintiffs did not dispute that both the investment tax credit and the Enterprise Zone tax abatements satisfied the nexus, apportionment and "fair relation" tests, but they argued that both types of tax incentives were discriminatory.

The Court of Appeals analyzed a number of U.S. Supreme Court decisions, relying mainly upon Boston Stock Exch. v. State Tax Comm’r., 429 U.S. 318 (1977), and Westinghouse Elec. Corp. v. Tully, 466 U.S. 388 (1984). The Court concluded that ". . . the investment tax credit . . . encourages the development of local business through the use of Ohio’s power to tax an instate operation as a means of requiring [other] business operations to be performed in the home State." This "hindered" free trade among the states and violated the Commerce Clause.

Property Tax Abatement For New Machinery And Equipment Found Constitutional Because It Did Not Reduce Any Existing Law Liability.

Under Ohio’s Enterprise Zone law, a municipality may offer specified personal property tax abatements to taxpayers that agree ". . . to establish, expand, renovate, or occupy a facility and hire new employees, or preserve employment opportunities for existing employees." R.C. 5709.62(C)(1). The critical and most frequently used abatement is the exemption, for up to ten years and up to 75%, of the assessed value of new machinery and equipment in a manufacturing facility. R.C. 5709.62(C)(1)(a).

The District court had upheld the property tax abatement even though the plaintiffs argued that "[a] taxpayer [that] agrees to focus [its] employment or investment in Ohio receives preferential treatment in the form of a tax break, while a taxpayer [that] prefers to preserve the freedom to hire or invest elsewhere does not."

The Court of Appeals held that "[a]lthough conditions imposed on property tax exemptions may independently violate the Commerce Clause, conditional exemptions raise no constitutional issues when the conditions for obtaining the favorable tax treatment are related to the use or location of the property itself. Stated differently, an exemption may be discriminatory if it requires the [taxpayer] to engage in another form of business in order to receive the benefit or is limited to businesses with a specified economic presence."

Ohio’s Enterprise Zone law did not impose any unconstitutional conditions. It requires new machinery and equipment in a new or expanded or renovated plant and either hiring or maintaining a certain number of employees. The Court held that these statutory conditions ". . . do not independently burden interstate commerce" and held the Enterprise Zone law constitutional.

We will report on any attempt to have the United States Supreme Court review this important decision.

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