DDI, INC. v. State ex rel. Clayburgh

• Citation: 2003 ND 32,657 N.W.2d 228
• Decision Date: 05 March 2003
• Docket Number: No. 20020241.,20020241.
• Parties: D.D.I., INC., Danov Corporation, and Estuary Corporation, Florida corporations, Plaintiffs and Appellees, v. STATE of North Dakota, by and through its Tax Commissioner, Rick CLAYBURGH, Defendant and Appellant.
• Court: North Dakota Supreme Court

657 N.W.2d 228

2003 ND 32

D.D.I., INC., Danov Corporation, and Estuary Corporation, Florida corporations, Plaintiffs and Appellees, v. STATE of North Dakota, by and through its Tax Commissioner, Rick CLAYBURGH, Defendant and Appellant.

No. 20020241.

Supreme Court of North Dakota.

March 5, 2003.

William P. Pearce (appeared), Pearce & Durick, Bismarck, ND, Richard A. Husseini (argued), Geoffrey Schultz (appeared), James Edward Maloney (on brief), Maryanne Lyons (on brief), Baker Botts L.L.P., Gerard Desrochers (on brief), Houston, TX, for plaintiffs and appellees.

Donnita A. Wald (argued), Special Assistant Attorney General and Robert W. Wirtz (appeared), Special Assistant Attorney General, Bismarck, ND, for defendant and appellant.

KAPSNER, Justice.

[¶ 1] The State of North Dakota, by and through its Tax Commissioner ("Commissioner"), appealed from a judgment declaring the dividends received deduction in N.D.C.C. § 57-38-01.3(1)(g) unconstitutional and enjoining collection of the Commissioner's assessments of corporate income tax against D.D.I., Inc., Danov Corporation, and Estuary Corporation (collectively referred to as "taxpayers").¹ We hold the dividends received deduction is not a valid compensatory tax and violates the Commerce Clause. We affirm.

I

[¶ 2] The taxpayers are Florida corporations engaged in managing assets, including oil and gas properties in North Dakota, and they pay North Dakota corporate income taxes on their net income from business done by them in North Dakota. The taxpayers also receive dividend income from other corporations conducting business either wholly or primarily outside of North Dakota. D.D.I. and Estuary initially excluded the dividends received from those other corporations in the calculation of their North Dakota corporate income tax for tax years 1989 through 1997, and Danov excluded those dividends for tax years 1989 through 1995. The Commissioner determined those dividends were business income subject to apportionment, and to the extent the Commissioner determined the dividends were includable in the taxpayers' North Dakota apportioned income, the Commissioner applied the dividends received deduction under N.D.C.C. § 57-38-01.3(1)(g), which authorizes adjustments to a corporation's taxable income and provides:

1. The taxable income of a corporation as computed pursuant to the provisions of the Internal Revenue Code of 1954, as amended, must be:

. . . .

g. Reduced by dividends or income received by any person from stock or interest in any corporation, the income of which has been assessed and paid by a corporation under this chapter or sections 57-35.3-01 through 57-35.3-12, received by the taxpayer and included in the gross income within the income year if such corporation has reported the name and address of each person owning stock and the amount of dividends or income paid each such person during the year, but when only part of the income of any corporation has been assessed and income tax paid under this chapter or sections 57-35.3-01 through 57-35.3-12, only a corresponding part of the dividends or income received therefrom may be deducted.

[¶ 3] The taxpayers brought this declaratory judgment action against the Commissioner, claiming the dividends received deduction violated the Commerce Clause. The trial court concluded the dividends received deduction violated the "negative" or "dormant" aspect of the Commerce Clause because the deduction was similar to a North Carolina "intangibles tax" held unconstitutional in Fulton Corp. v. Faulkner, 516 U.S. 325, 116 S.Ct. 848, 133 L.Ed.2d 796 (1996). The Commissioner appealed.

II

[¶ 4] The Commerce Clause, U.S. Const. art. I, § 8, cl. 3, grants Congress the power "[t]o regulate commerce... among the several States." Although the Commerce Clause is phrased as a grant of power to Congress, it has long been understood to have a "negative" or "dormant" aspect that denies states the power unjustifiably to discriminate against or burden the interstate flow of articles of commerce. Fulton, 516 U.S. at 330, 116 S.Ct. 848; Oregon Waste Sys., Inc. v. Department of Envtl. Quality, 511 U.S. 93, 98, 114 S.Ct. 1345, 128 L.Ed.2d 13 (1994). The Commerce Clause grants Congress plenary authority over interstate commerce to avoid the economic balkanization that had plagued relations among the colonies and later among the states under the Articles of Confederation. Oregon Waste, at 98, 114 S.Ct. 1345. The "negative" or "dormant" aspect of the Commerce Clause prohibits economic protectionism designed to benefit in-state economic interests by burdening out-of-state competitors. Fulton, at 330, 116 S.Ct. 848.

[¶ 5] In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 288-89, 97 S.Ct. 1076, 51 L.Ed.2d 326 (1977), the United States Supreme Court rejected a formalistic approach to Commerce Clause challenges to state taxes. See generally 1 Jerome R. Hellerstein and Walter Hellerstein, State Taxation ¶ 4.11[1] (3rd ed.2001). The Court recognized that entities engaged in interstate commerce were not immune from state taxation and said "`"[i]t was not the purpose of the commerce clause to relieve those engaged in interstate commerce from their just share of state tax burden even though it increases the cost of doing business." Western Live Stock v. Bureau of Revenue, 303 U.S. 250, 254, 58 S.Ct. 546, 82 L.Ed. 823 (1938).'" Complete Auto, at 288, 97 S.Ct. 1076 (quoting Colonial Pipeline Co. v. Traigle, 421 U.S. 100, 108, 95 S.Ct. 1538, 44 L.Ed.2d 1 (1975)). The Court articulated a four-part test under which a state tax would be sustained against a Commerce Clause challenge if (1) the tax was applied to an activity with a substantial nexus with the taxing state, (2) the tax was fairly apportioned, (3) the tax did not discriminate against interstate commerce, and (4) the tax was fairly related to the services provided by the state. Complete Auto, at 279, 287, 97 S.Ct. 1076.

[¶ 6] Here, the dispositive issue under that four-part test is whether the dividends received deduction discriminates against interstate commerce. In Oregon Waste, 511 U.S. at 99, 114 S.Ct. 1345, the Court defined "discrimination" to mean "differential treatment of in-state and out-of-state economic interests that benefits the former and burdens the latter." See also Fulton, 516 U.S. at 331, 116 S.Ct. 848 (quoting Chemical Waste Mgmt., Inc. v. Hunt, 504 U.S. 334, 342, 112 S.Ct. 2009, 119 L.Ed.2d 121 (1992) for principle that statute is discriminatory if it "tax[es] a transaction or incident more heavily when it crosses state lines than when it occurs entirely within the State"). State laws that facially discriminate against interstate commerce are subject to the "strictest scrutiny" and are "virtually per se invalid." Fulton, at 331, 344, 116 S.Ct. 848; Oregon Waste, at 99-101, 114 S.Ct. 1345.

[¶ 7] The Commissioner concedes the dividends received deduction facially discriminates against interstate commerce. A facially discriminatory tax may survive Commerce Clause scrutiny if the tax is a "compensatory" or "complementary" tax that requires interstate commerce bear a burden already born by intrastate commerce. Fulton, 516 U.S. at 331-33, 116 S.Ct. 848. The compensatory or complementary tax doctrine assures that "`[w]hen the account is made up, the stranger from afar is subject to no greater burdens as a consequence of ownership than the dweller within the gates. The one pays upon one activity or incident, and the other upon another, but the sum is the same when the reckoning is closed.'" Fulton, at 332, 116 S.Ct. 848 (quoting Henneford v. Silas Mason Co., 300 U.S. 577, 584, 57 S.Ct. 524, 81 L.Ed. 814 (1937)). In Fulton, at 332-33, 116 S.Ct. 848, the Court enunciated three requirements for a valid compensatory tax:

First, "a State must, as a threshold matter, `identif[y] ... the [intrastate tax] burden for which the State is attempting to compensate.'" Oregon Waste, supra, at 103 (quoting Maryland v. Louisiana, 451 U.S. 725, 758[, 101 S.Ct. 2114, 68 L.Ed.2d 576] (1981)). Second, "the tax on interstate commerce must be shown roughly to approximate —but not exceed—the amount of the tax on intrastate commerce." Oregon Waste, 511 U.S. at 103. "Finally, the events on which the interstate and intrastate taxes are imposed must be `substantially equivalent'; that is, they must be sufficiently similar in substance to serve as mutually exclusive `prox[ies]' for each other." Ibid. (quoting Armco Inc. v. Hardesty, supra, at 643).

[¶ 8] The Commissioner argues the dividends received deduction must be presumed constitutional because statutes enjoy a strong presumption of constitutionality in North Dakota, see MCI Telecomms. v. Heitkamp, 523 N.W.2d 548, 552 (N.D.1994), and the taxpayers have failed to prove beyond a reasonable doubt the dividends received deduction is unconstitutional. Although there is a presumption that statutes are constitutional, facially discriminatory restrictions on interstate commerce are subject to the strictest scrutiny and are virtually per se invalid, and the State must establish the requirements for a valid compensatory tax. Fulton, 516 U.S. at 332, 344, 116 S.Ct. 848; Oregon Waste, 511 U.S. at 99-101, 114 S.Ct. 1345.

[¶ 9] The Commissioner argues the dividends received deduction is a valid compensatory tax. The Commissioner argues the "intangibles tax" found unconstitutional in Fulton and the dividends received deduction in this case are not similar. We reject the Commissioner's arguments.

[¶ 10] In Fulton, 516 U.S. at 328, 116 S.Ct. 848, the Supreme Court described North Carolina's "intangibles tax" on the fair market value of corporate stock owned by North Carolina residents:

[A] corporation doing all of its business within the State would pay corporate income tax on 100% of its income, and the taxable percentage deduction allowed to resident owners of that corporation's stock under the intangibles tax would likewise be 100%. Stock in a

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