06-125 | Virginia Tax

Tax Type

Corporation Income Tax

Description

Agricultural credit associations not immune from state taxation

Topic

Agricultural

Credits

Date Issued

10-03-2006

October 3, 2006

Re: Protective Claims for Taxable Years 1990 through 2000

Dear *****:

This will reply to the protective claims of *****, *****, *****, *****, ***** (the "Taxpayers") regarding taxable years 1990 through 2000.

FACTS

The Taxpayers are structured as agricultural credit associations ("ACAs"). The Farm Credit Act of 1987 allowed for the creation of ACAs through the merger of two types of farm credit associations: production credit associations ("PCAs") and federal land bank associations ("FLBAs"). Both of these types of organizations were designated as federally chartered instrumentalities of the United States. 12 U.S.C. §§ 2071(a) and 2091(a). In addition, when these organizations were initially formed, they were either wholly or partially owned by the federal government. At this time, however, every farm credit association is wholly owned by its borrower/members.

Congress created tax exemptions for the original farm credit associations based on the type of lending that each association offered. FLBAs serviced, and in some cases issued, long-term mortgage loans to farmers. 12 U.S.C. § 2093. These associations have enjoyed tax immunity from federal, state and local taxation, except for taxes on real estate, since they were first created. 12 U.S.C. § 2098.

PCAs, on the other hand, issued short and intermediate-term loans for agricultural or aquatic purposes. 12 U.S.C. § 2075(a)(1). These associations have only enjoyed limited tax immunity. Until 1985, the income of PCAs was exempt from taxation as long as the government owned at least a portion of the organization. In 1985, Congress repealed the language granting the tax exemption for income. The notes, debentures and other obligations issued by PCAs, however, are currently exempt from state taxation. 12 U.S.C. § 2077.

The Virginia Department of Taxation has been holding protective claims for the Taxpayers pending the outcome of several court cases. Three sets of claims have been filed for most of the applicable taxable years.

The first set of claims requests a refund of income taxes paid on one hundred percent of the income earned by the Taxpayers. The basis for this theory is that because, under the enabling statute, ACAs inherit the powers and obligations of the merged associations, ACAs succeed to the income tax immunity that was enjoyed by the predecessor FLBAs. This argument also contends that ACAs are federal instrumentalities and, as such, are exempt from taxation.

The second set of claims requests a full refund of the income tax paid on the amount of income from long-term mortgage activities. This claim is based on the difference in the level of tax immunity that was previously granted to the predecessor associations: FLBAs and PCAs. While PCAs had only a limited tax exemption, the income of FLBAs was completely exempt from state taxation. Thus, the Taxpayers claim that because their income from long-term lending activities would have been exempt from all state taxation if they were FLBAs, the income should also be exempt for the Taxpayers.

Finally, the last set of claims requests a refund of the income tax paid on sixty percent of the income from the long-term lending activities of the Taxpayers. These claims are based on settlements that previously occurred between the Taxpayers and the Internal Revenue Service on this issue, which adjusted the federal taxable income for all of the Taxpayers.

RULING

Recently, you indicated that the Taxpayers are willing to abandon their claims to a one hundred percent exemption from the state income tax based on their status as federal instrumentalities. In addition, you stated that the Taxpayers are also willing to withdraw their claims for an exemption regarding the long-term mortgage lending income. In exchange, you request that the Department approve the protective claims filed to report the reductions in federal taxable income as a result of the settlement with the Internal Revenue Service.

In support of this offer, you pointed to a decision issued by the Circuit Court for Baltimore City, Colonial Farm Credit, ACA v. Comptroller of the Treasury, Case No. 24C-0500022-4 (Cir. Ct. for Baltimore City, December 7, 2005). In that case, an ACA requested a refund based on a closing agreement entered into with the Internal Revenue Service, which decreased the ACA's taxable income to exclude sixty percent of its long-term taxable income. The Comptroller of Maryland, however, refused to accept the reduction to taxable income and, thus, would not issue the corresponding refund. The Tax Court ruled in favor of the Comptroller and the case was appealed to the Circuit Court for Baltimore City.

After reviewing the facts, the Circuit Court for Baltimore City determined that, in this case, the closing agreement was a final and conclusive determination regarding the ACAs long-term mortgage activities. Therefore, because Maryland conforms to federal taxable income, the Comptroller was bound by that federal treatment. Accordingly, the Court approved the claimed refunds.

Although the Baltimore case is clearly not binding on the Commonwealth, I do find the reasoning applied by the court to be persuasive. Thus, because Virginia also conforms to federal taxable income and because we wish to promote consistency with the federal system, the Virginia Department of Taxation will follow the tax treatment established by the Internal Revenue Service and exclude from taxable income sixty percent of the long-term lending activity income earned by the Taxpayer to the extent that such income was excluded under the settlement agreement with the IRS. The protective claims reflecting this settlement were timely filed and will be forwarded for processing.

In a later conversation, you also requested that the Department agree to a similar sixty percent refund for those taxable years in which protective claims did not request a refund based on a federal settlement, apparently because there was no federal settlement for those taxable years. In this situation, the Commonwealth must determine the appropriate manner in which to treat the income of ACAs that has been fully taxed for federal purposes. Court decisions from the United States Supreme Court and the Supreme Court of Ohio have provided guidance on this issue.

United States Supreme Court

The case of Director of Revenue of Missouri v. CoBank ACB, 531 U.S. 316 (2001) is the most recent Supreme Court decision concerning this issue. This case was the result of an appeal from Production Credit Association of Southeastern Missouri v. Director of Revenue, 10 S.W.3d 142 (2000), in which the Missouri Supreme Court found that the organization CoBank was exempt from state taxation. Id. at 143.

CoBank was structured as an agricultural credit bank (ACB) under the farm Credit Act. Just as ACAs are combinations of PCAs and FLBAs, ACBs have the combined authority of a bank for cooperatives and a farm credit bank. While CoBank did not focus on CoBank's tax status as an ACB, the question presented concerned the tax status of one of the entities that was merged into CoBank, the National Bank for Cooperatives. The National Bank for Cooperatives operated as a bank for cooperatives prior to the merger. Banks for cooperatives, like PCAs, are federal instrumentalities. As the Court noted in its opinion, "the statutory history and provisions regarding the taxation of production credit associations and banks for cooperatives are virtually identical . . . ." CoBank, 531 U.S. at 321. Therefore, the rationale in the Court's decision should also apply to PCAs.

In CoBank, the case dealt with a technical amendment to the Farm Credit Act in 1985. This amendment removed two sentences that had granted an exemption from state taxation to banks for cooperatives and limited that exemption to periods when the Governor of the Farm Credit Administration held stock in the bank. Id. at 323. CoBank argued that, ". . . because the deletion eliminated the express statutory authority for such taxation, Congress intended banks for cooperative to be immune from state taxation under [the] implied immunity doctrine." Id.

The Court disagreed with CoBank's interpretation and stated, "Had Congress simply deleted the final sentence of § 2134 that limited the exemption, we would have no trouble concluding that Congress had eliminated the States' ability to tax banks for cooperatives. Short of this act, however, we find Congress' silence insufficient to disrupt the 50-year history of state taxation of banks for cooperatives." Id. at 324.

Finally, in a point more relevant to the current discussion, the Court wrote:

- Had Congress intended to confer upon banks for cooperatives the more comprehensive exemption from taxation that it had provided to farm credit banks and federal land bank associations, it would have done so expressly as it had done elsewhere in the Farm Credit Act. Thus, in light of the structure of the Farm Credit Act -- and the explicit grant of immunity to other institutions within the Farm Credit System -- Congress' silence with respect to banks for cooperatives indicates that banks for cooperatives are subject to state taxation.

Id. at 325.

As a result of these findings, the Supreme Court determined that the income of banks for cooperatives is subject to state taxation. Thus, mere designation as a federal instrumentality is not enough to exempt an entity from state taxation. In addition, because PCAs are so similar, it may be inferred that the income of these organizations is also subject to state taxation. The CoBank decision, however, left unanswered the question of whether the income of ACAs is taxable by the states.

Supreme Court of Ohio

The question of whether the income of ACAs is taxable by the states was addressed by the Supreme Court of Ohio later that same year in the case Farm Credit Services of Mid-America v. Zaino, 91 Ohio St.3d 564 (Ohio 2001), cert. denied, 534 U.S. 1019 (2001). Since the CoBank decision in 2001, the Zaino decision has been the only major state supreme court decision involving this issue.

In Zaino, a PCA and two FLBAs merged to create an ACA called Farm Credit Services of Mid-America. This ACA argued that it was immune from state taxation under the Supremacy Clause. Id. at 565. Using the premises advanced by the United States Supreme Court in CoBank, the Supreme Court of Ohio reasoned that if Congress had intended for ACAs to be exempt from taxation, it would have included such an exemption in the enabling statute for ACAs just as had done for FLBAs. The court wrote, "Congress has exempted federal land banks from Ohio's franchise tax but has not exempted production credit associations. We have, however, neither of these entities before us; we have an agricultural credit association ('ACA') . . . Congress has not expressed an immunity from taxation for an ACA." Id. at 566-567.

Since the ACA does not have an express immunity from state taxation, the court went on to consider whether it holds an implied immunity. In an earlier case, the Supreme Court of the United States wrote, ". . . tax immunity is appropriate in only one circumstance: when the levy falls on the United States itself, or on an agency or instrumentality so closely connected to the Government that the two cannot be realistically viewed as separate entities." United States v. New Mexico, 455 U.S. 720, 735 (1982). In Zaino, the court found that the ACA is "...a privately owned business benefiting private interests . . . It does not stand in the federal government's shoes . . . ." 91 Ohio St.3d at 567. Therefore, the ACA is not entitled to implied immunity from state taxation.

Finally, the court rejected the argument that the ACA, as part of the powers and obligations that it assumed from FLBAs under its enabling statute, assumed the tax immunity of the FLBAs. "According to normal usage, 'powers' refers to the activities and actions the predecessor entities may undertake, and 'obligations' refers to the debts, contractually and otherwise acquired duties that the predecessor entities have undertaken." Id. at 568. Thus, the ACA does not inherit the tax immunity held by the predecessor FLBA.

As a result of these findings, the Supreme Court of Ohio found that the entire income of the ACA was subject to state taxation. Farm Credit Services of Mid-America later appealed this case to the United States Supreme Court; but it was denied certiorari. 534 U.S. 1019 (2001).

Conclusion

The decisions of the United States Supreme Court and the Supreme Court of Ohio are persuasive. Congress did not provide an explicit income tax exemption for ACAs as it had done in the past for FLBAs. As the United States Supreme Court wrote in CoBank, "With respect to each lending institution in the Farm Credit System, the Act contains a taxation provision that specifically delineates the immunity from taxation enjoyed by that entity." 531 U.S. at 324. Thus, if Congress had intended to grant an exemption from state taxation for the income of ACAs as it did for "federal land bank associations, it would have done so expressly as it had done elsewhere in the Farm Credit Act." Id. at 325.

In addition, the reasons for which the income of PCAs and FLBAs was granted at least a limited tax immunity are not present for ACAs. ACAs are not wholly or partially owned by the federal government, as PCAs and FLBAs were when they were first established. Also, the enabling statute for ACAs does not provide that they are federal instrumentalities of the United States, as was done for PCAs and FLBAs. Thus, ACAs are private entities rather than federal instrumentalities; and, as such, they are subject to state taxation. As the Ohio Supreme Court stated, "If Congress does not explicitly [provide an exemption), the Supremacy Clause does not supply an implicit exemption to a privately owned entity that lends funds to private individuals." Zaino, 91 Ohio St.3d at 568.

Finally, in a memo dated November 21, 1997, which supported the protective claim for a refund of one hundred percent of the income tax paid, the Taxpayers relied on a case that was ultimately decided by the Arkansas Supreme Court. Arkansas v. Farm Credit Services of Central Arkansas, 338 Ark. 322 (Ark. 1999), cert. denied, 529 U.S. 1036 (2000). This case held that PCAs are federal instrumentalities and that, as such, they are entitled to implied immunity from taxation. The Taxpayers argued that, although ACAs are not statutorily designated federal instrumentalities, they do function as such and, as a result, should be exempt from state taxation. We do not find this argument persuasive. Even if we accepted that ACAs are federal instrumentalities, however, the subsequent opinion by the United States Supreme Court in CoBank clearly demonstrated that federal instrumentalities are not automatically exempt from state taxation.

For those taxable years in which protective claims are not based on a federal settlement, we will not provide a sixty percent refund of the long-term lending activity income earned by the Taxpayers. In addition, all of the protective claims seeking a refund of one hundred percent of the Taxpayer's income tax are hereby denied. I must also deny all of the requests for a refund for the income tax that was paid on one hundred percent of the long-term lending activity income of the Taxpayer.

I trust that this reply responds to all of your issues. If you should have any tax questions regarding this ruling, you may contact ***** in the Office of Policy, Policy Development, at *****.

- - - - Sincerely,

- - - - Janie E. Bowen
        Tax Commissioner

Rulings of the Tax Commissioner