High Court Levels the Field: How an Arcane Tax-Law Case - Hinging Partly on a Congressional Error - May Help Ag Banks Compete with Production Credit Associations

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How an arcane tax-law case--hinging partly on a congressional error--may help ag banks compete with production credit associations

Ag bankers have long complained about the tax advantages of the country's production credit associations, which comprise an arm of the Farm Credit System. A recent court case may help even the odds between ag banks and PCAs.

Approximately 65 PCAs do business around the country. PCAs are one of several types of local lending organizations under the Farm Credit System's umbrella. They make short- and medium-term loans to farmers and ranchers. PCAs borrow money from their area farm credit bank to lend to farmers, who must belong to the PCA through stock ownership--5% of the loan or $1,000, whichever is less--in order to borrow. (In times past, the government had ownership in PCAs, but that is no longer the case--and that is a key issue in the case we'll be examining.)

Officially, PCAs lack the power to accept deposits. However, in some parts of the country, PCAs permit prepayment of loans, even up to 100%, in a quasi-deposit-taking role. Borrowers receive interest on the prepaid amounts.

Ag lenders and state tax administrators nationwide anxiously awaited the outcome of a U.S. Supreme Court case known as State of Arkansas v. Farm Credit Services of Central Arkansas, PCA, et. al. On June 2, 1997, the Court unanimously decided to reverse a prior ruling in the Eighth Circuit Court of Appeals, which held that PCAs, as federal instrumentalities, were constitutionally immune from Arkansas state sales and use tax.

The import of the high court's decision has already spread beyond the ag world. Several cases have been reversed, including one involving a federal credit union employee's claim for an exemption from a transient hotel tax. This trend indicates that subsequent claims of tax immunity will be subject to judicial scrutiny.

Limited federal ownership nullifies immunity

Attempts to gain immunity based upon designation as a federal instrumentality is not a recent development. Supreme Court cases dating back to the early 1800s established an inter-governmental immunity doctrine in an effort to create and enforce a system of federalism in our government's infancy. Justice John Marshall created the doctrine in M'Culloch v. Maryland, an 1819 case.

In contrast, modern federal instrumentalities, simply designated as such in some statutes--including PCAs and federal credit unions--are vastly different from the centuries-old perception of federal instrumentalities. Distinguishing characteristics of these modern instrumentalities include limited or nonexistent federal ownership or control; operation and structuring for profit; and direct competition with similarly situated private-sector entities. These distinguishing characteristics provide the essence of the arguments presented by the State of Arkansas and the organizations, including ABA, which filed supporting briefs with the Supreme Court.

The makings of a case

In June 1994, four federally chartered Arkansas PCAs brought suit in federal district court, claiming an exemption from Arkansas sales and income tax. Arkansas tax authorities had denied the PCAs' request for tax refunds plus formal recognition that they were exempt from state taxation. The federal district court ruled in favor of the PCAs, finding that PCAs are federal and therefore immune from state tax. Further, the district court noted that such immunity must be expressly waived by Congress in order to subject PCAs to state taxation. Arkansas' appeal to the Eight-Circuit Court of Appeals was unsuccessful.

In April of this year, the U.S. Supreme Court agreed to hear the case. In support of Arkansas' position, ABA and the Nebraska Bankers Association jointly filed a friend-of-the-court brief.

Numerous arguments support state taxation of PCAs and they are supported by statutory and judicial precedent. …

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