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High Court Upholds Dichotomy in Tax Case

Fortnightly Magazine - March 15 1997

The U.S. Supreme Court in late February ruled that it is constitutional for Ohio to impose a 5-percent use tax on purchases of natural gas from an out-of-state natural gas marketer, when the same purchases would have been exempt from tax had the purchaser bought the gas from an in-state local distribution company.

Nicholas Bush, Natural Gas Supply Association president, expressed disappointment with the decision and called it a setback for development of a national, competitive natural gas marketplace. "While it is important to recognize the rights of an individual state over its businesses, it is difficult to achieve a prosperous national economy without consistent and fair rules for interstate commerce."

General Motors had challenged the constitutionality of the tax exemption for local distribution companies, alleging the exemption discriminates against interstate commerce by encouraging purchases from the distribution companies rather than from out-of-state competitors (General Motors Corp. v. Tracy, Tax Commissioner of Ohio, No. 95-1232).

The Supreme Court disagreed with General Motors, ruling 8-1 in favor of Ohio on Feb. 18. Justice Souter wrote in an opinion that the local distribution companies' bundled products reflected the demand of a core market. This core market is typified by residential customers that could on rate stability and gas supply, and "that is neither susceptible to competition by the interstate sellers, nor likely to be served except by regulated natural monopolies," he wrote.

The noncompetitive market would not see increased competition by eliminating the tax differential, the court said. Elimination of the tax could intensify competition between local distribution companies and marketers for noncaptive bulk buyers such as GM, which have no need for bundled protection. For Commerce Clause purposes, the court said, it is more important to give greater weight to the distinctiveness of the captive market and the singular role of the distribution companies in serving that market, therefore treating marketers and local distribution companies as dissimilar.

The court pointed out that its intervention could "threaten the preservation of an adequate customer base to support continued provision of bundled services to the captive market." It is up to Congress to make any changes to the scheme that has evolved.

According to Bill Kimble, national partner in charge, KPMG Peat Marwick, State and Local Tax Services, Utilities Practice, in another case, Fulton Corp. v. Faulkner, 116 S.Ct. 848 (1996), the court clearly indicated its lack of tolerance for taxes that discriminate against interstate commerce. But in the GM case, the court used a different analysis in upholding the tax. The court identified as a threshold question whether local distribution companies and independent marketers are similarly situated for constitutional purposes, and concluded they are not. Outside a regulated industry, where Congress has not intervened, the court may be more likely to adhere to fulton's near per se rule of invalidity, Kimble concluded.

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