Zimmer, Duncan & Cole

That's No Way to Treat a Railroad

Midwest Railcar Repair is located just north of Corson, South Dakota, along a spur of the Burlington Northern Santa Fe Railroad. Each month, Midwest fixes around 200 cars of all types: flatbeds; hoppers; tankers; and boxcars.
The company's services include warranty repairs; refurbishing wrecks; paint jobs and decals; and reconditioning railcars after the end of a lease. Many parts are fabricated on-site. The company even has a kosher-certification for food-grade tankers.
Its customers include railroads like Burlington Northern. When it bills the customer for the parts and services provided, our Department of Revenue collects an extra 4% sales tax on each transaction.
Midwest believed that this sales tax violated federal law and brought a lawsuit.
Very few disputes end up in federal court. By design, Congress has limited the type of cases that its federal judges are allowed to hear.
A federal lawsuit must either involve some question of federal law or a major dispute between citizens of different states. In contrast, state courts have broad, general jurisdiction to hear almost any kind of case.
The federal law involved in this week's case is a mouthful: the Railroad Revitalization and Regulatory Reform Act of 1976.
The 4-R Act was passed at a critical and uncertain time for America's railroads. Increasing competition from airlines and the Eisenhower Interstate System had led to the bankruptcies of the Pullman passenger car company and many major railways.
As lawmakers sorted through the rubble, they flirted with the idea of nationalizing the passenger and freight systems. Spurred by the leadership of President Ford, Congress enacted sweeping reforms that attempted to put the future of freight rail in the hands of market forces, rather than government regulators.
Within five years, the newly created Conrail freight line was turning a profit and was then sold to private investors. (On the passenger side, Amtrak is still in public hands today and has never turned a profit.)
A key component of the 4-R legislation was its strict limitation on taxation by state and local governments.
For over a century, railroads had been sitting ducks for local taxes. A railroad is usually from out-of-state; it is perceived to be very wealthy; and it is extremely difficult for a railroad to pack up its track and leave if it disagrees with a tax.
In response, the 4-R Act attempted "to remove the temptation to excessively tax railroads". Any state or local tax that discriminates against railroads is now prohibited.
Over the years, our courts recognized that certain taxes could result in unfair treatment of railroads, even though the tax was levied upon a third party.
The key in those cases is whether the tax on the third party has a discriminatory effect against railroads.
Here, Midwest Railcar pointed out that as a supplier of parts and services directly to railroads that any tax on its transactions necessarily affected each railroad's bottom line.
The Department of Revenue disagreed, as did the Court of Appeals. In short, the relationship between Midwest Railcar and the railroads was not close enough.
The Court explained that in previous cases, the third-parties were essentially corporate subsidiaries or adjuncts of the railroads. Here, Midwest Railcar was viewed as an unaffiliated business that merely provides repair services directly to railroads.
If that sounds like a distinction without a difference, then you're in the same camp as Judge Kermit Bye, who dissented in this 2-1 decision.
He questioned the majority's analysis and pointed out that the test is "whether the tax increases the cost of an activity to a rail carrier's detriment." Here, it does. So Judge Bye would have invalidated the tax.
In federal appeals, this is not necessarily the end of the road. In rare cases, the rest of the 11 circuit court judges can decide to rehear the case. Or, the U.S. Supreme Court can take up the issue. If neither of those occurs, the tax on railcar repairs will stand.

http://www.ca8.uscourts.gov/cgi-bin/new/getDocs.pl?case_num=10-2630&from=inter