Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
Close but No Cigar: Is a Use Tax Valid in a Gross Receipts Tax State Under the Supreme Court's Compensating Tax Doctrine?
Reid S. Okimoto*
Evaluation of a discriminatory state tax under the Commerce Clause is a unique inquiry. Unlike determining constitutional validity under the Equal Protection or Due Process Clauses, the Commerce Clause requires a much stricter standard. Under the Commerce Clause, a tax found to discriminate against interstate commerce is per se invalid. Under this analysis, the intent of the state and the magnitude of the disparity are irrelevant. Thus, any amount of benefit favoring intrastate commerce over interstate commerce will be deemed unconstitutional. The only known “exception” to this rule is the compensating tax doctrine.
The compensating tax doctrine is often described as an “exception,” “justification,”or even a “defense” to a facially discriminatory tax. However, the doctrine is really none of these as it does not operate to allow the application of a tax despite its discriminatory effect. Rather, it establishes another way of evaluating a tax under the Commerce Clause by expanding the scope of the analysis to include the state’s whole tax regime, not just the statute imposing the alleged discriminatory tax. Under this approach, if a state tax imposes a burden on interstate commerce, the court can evaluate other parts of the state tax code to determine whether a corresponding equal burden is imposed on intrastate commerce. The most common illustration is a sales tax and a compensating use tax. When viewed separately, a use tax applies only to purchases of out-of-state goods imported into the taxing state. However, taken together, the use tax is viewed as an equivalent to the sales tax. This is because a consumer will pay either the sales or use tax, but not both, on all purchases whether imported from another state or purchased from a retailer within the state.
This Article is divided into two parts. Part II provides an overview of the Supreme Court’s jurisprudence in the area of discriminatory taxes and the operation of the compensating tax doctrine. Part III focuses on applying these concepts to state taxes levied on in-state consumers to compensate for gross receipts (or similar business level excise taxes) imposed on out-of-state businesses. The Article concludes that under the Supreme Court’s compensating tax doctrine, a use tax levied on an in-state customer could be found invalid in a pure gross receipts tax state because the incidences of the two taxes are on different taxpayers.
*Manager, KPMG LLP, in the firm’s Seattle Office; Part-time Lecturer, University Of Washington, School Of Law Graduate Program in Taxation (LL.M.) and School of Business Master of Professional Accounting (Taxation)