In Macy’s Department Stores, Inc. v. City and County of San Francisco, (— Cal.Rptr. 3d —, 2006 WL 2960743, Cal.App. 1 Dist., Oct. 18, 2006), a California Court of Appeal addressed the issue of whether a business whose tax liability was computed under a city tax scheme that violated the Interstate Commerce Clause because it discriminated against interstate businesses was entitled to a full refund of all the taxes it paid. The Court of Appeal held that the business was not entitled to a full refund and that the refund must be limited to an amount sufficient to cure the discriminatory effect of the tax imposed by the city.
Facts
Between 1995 and 1999, San Francisco (“City”) ordinances required businesses operating within the City to calculate their tax liability separately under payroll expense and gross receipt taxes and then pay the greater of these two amounts. Macy’s Department Stores, Inc. (“Macy’s”) filed refund claims for all taxes paid between 1995 and 2000 on the ground that the ordinances violated both the federal Commerce Clause and the corresponding protections afforded under the California Constitution. After City denied the claims for refunds, Macy’s filed a lawsuit against City. The trial court found that City’s tax scheme violated the federal and state constitutions and ordered City to refund all of the taxes paid by Macy’s from 1995 to 1999.
Decision
The Commerce Clause of the United States Constitution reserves to Congress the power to regulate commerce between states. The Commerce Clause has been interpreted to prevent or limit the ability of state and local governments to pass laws that negatively affect interstate commerce. The test used to determine if a state or local tax has a negative impact on interstate commerce is the internal consistency test. “Internal consistency is preserved when the imposition of a tax identical to the one in question by every other State would add no burden to interstate commerce that intrastate commerce would not also bear.” The failure to achieve internal consistency “shows as a matter of law that a State is attempting to take more than its fair share of taxes from the interstate transaction, since allowing such a tax in one State would place interstate commerce at the mercy of those remaining States that might impose an identical tax.” The Court of Appeal noted that this same test has been applied by California courts to determine if a local tax violates the California Constitution.
City did not appeal the trial court’s determination that its tax scheme is unconstitutional because its fails the internal consistency test. The Court of Appeal noted, in isolation, the payroll and gross receipts taxes are valid. However, it determined that the tandem interaction of the taxes violated the internal consistency test. The City did, however, assert on appeal that it was not required to pay Macy’s a full refund. The Court noted that federal law does not dictate the remedy to be awarded if a state or local tax is unconstitutional; states are left to determine the exact remedy for discriminatory taxation. The Court opined that due process does not compel a full refund of all taxes paid in all cases. Here, the Court determined that Macy’s was only entitled to be placed in a position that is equivalent to the position occupied by local taxpaying businesses. Macy’s was not entitled to a full refund of all taxes paid because such a refund would place it in a more favorable position than a local taxpayer. The Court held that “City may limit Macy’s tax refund to the amount necessary to remedy any discrimination” from the tandem tax scheme.
The Court further held that the amount of prejudgment interest payable on the tax refund should not be determined by a local ordinance that provides for a variable interest rate. The Court found that the local ordinance providing for a variable rate conflicts with Civil Code section 3287 and the California Constitution which “operate together to require the payment of interest on tax refunds at a rate of seven percent, from the time the right to recover is vested in the taxpayer.”
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