PCA and Supremacy Clause Immunity

March 01, 1999

Summary
On February 15, 1999, Production Credit Association of Eastern New Mexico perfected an appeal to the New Mexico Court of Appeals from a decision and order of the New Mexico Taxation and Revenue Department's internal Hearing Officer denying a claim for refund based upon Supremacy Clause immunity from state taxation. The taxpayer is a congressionally created and federally chartered component of the federal Farm Credit System that for over sixty years Congress has stated is a federal instrumentality by statute. The Hearing Officer held that the Supremacy Clause did not shield the taxpayer from New Mexico's income tax even though Congress had not expressly waived its constitutional immunity from state taxation.

Federal Production Credit Association Appeals Denial of Claim for Refund Based Upon Supremacy Clause Immunity From State Taxation

On February 15, 1999, Production Credit Association of Eastern New Mexico perfected an appeal to the New Mexico Court of Appeals from a decision and order of the New Mexico Taxation and Revenue Department's internal Hearing Officer denying a claim for refund based upon Supremacy Clause immunity from state taxation. The taxpayer is a congressionally created and federally chartered component of the federal Farm Credit System that for over sixty years Congress has stated is a federal instrumentality by statute. The Hearing Officer held that the Supremacy Clause did not shield the taxpayer from New Mexico's income tax even though Congress had not expressly waived its constitutional immunity from state taxation.

Since McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316 (1819), state and federal courts have held that federal instrumentalities are immune from state taxation under the Supremacy Clause of the United States Constitution, unless Congress expressly and unequivocally waives that immunity. In general terms, a federal instrumentality is an entity created or sanctioned by the federal government to carry out federal policies and goals that is not part of the government itself. For example, the United States Supreme Court has held that the American Red Cross is a federal instrumentality immune from state taxation because it carries out important public functions strongly supported by the federal government. McCulloch involved Maryland's attempt to impose tax obligations upon the First Bank of the United States, a for-profit privately owned bank that also served governmental purposes authorized by Congress. Since that time, courts have held that a wide variety of privately owned financial institutions created by Congress are federal instrumentalities constitutionally immune from state taxation in the absence of Congressional action to waive the immunity, including national banks, credit unions and federal land banks.

Production credit associations are not commercial banks but local components of what is known today as the federal Farm Credit System. The Farm Credit System began in 1916 when Congress created federal land banks. Since that time, the System has evolved into a multi-tiered set of financial institutions. The purpose of the System was and continues to be to provide farmers and ranchers credit not available or affordable from commercial lenders. Congress has added to, modified and infused cash into the system several times to address changes in banking and agriculture, as well as periodic depressions in the agricultural economy that have jeopardized the solvency of the System.

In 1933, Congress created and provided for federal capitalization of production credit associations to provide short and medium term loans at the local level after more distant centralized lending entities had proven unsatisfactory. At that time and to the present Congress has declared them to be federal instrumentalities. Production credit associations are formed by farmers and ranchers within a given region that want to borrow funds through the Farm Credit System. Only farmers and ranchers may borrow from production credit associations for farm and ranch purposes. Farmers and ranchers must purchase stock in a production credit association in proportion to the size of loan sought, but have only one vote in association affairs regardless of the amount of stock held. Production credit associations typically do not pay dividends to their borrower/stockholders, though if they do, courts have held that it is effectively a reduction in interest for loans taken out by the stockholder.

Production Credit Association of Eastern New Mexico filed a claim for refund of state income taxes paid in 1992-1996 because of its constitutional immunity. The Taxation and Revenue Department denied the claim administratively, as well as before its internal Hearing Officer. The internal Hearing Officer held that the Association's immunity from state taxation was statutory, not constitutional, and that Congress's express 1985 repeal of the prior limited waiver of immunity was actually an implied enactment of a much broader waiver of immunity. The Hearing Officer's ruling is contrary to the ruling of the federal Eighth Circuit in Farm Credit Services of Central Arkansas v. Arkansas, 76 F.3d 961 (8th Cir.1996), rev'd on other grounds, 117 S.Ct. 1776 (1997). In that case, the court held that after the 1985 amendments several production credit associations were immune from state taxation under the supremacy clause. The Supreme Court, however, held that the federal courts did not have jurisdiction under the Tax Injunction Act and reversed without reaching the merits. Last July, in state court, an Arkansas trial court again held that the associations were immune from state taxation. The Indiana Tax court has also issued similar rulings in the past couple of years relating to similar Farm Credit System entities.