APPENDIX 14

The Question of Possible Discrimination Against Out-of-State National Banks

SHELDON L. AZINE

Assistant to Counsel, Federal Reserve Bank of Minneapolis

Public Law 91-156, commonly referred to as the National Bank Tax Act, was signed into law on December 24, 1969. Effective dans uary 1, 1972, section 5219 of the Revised Statutes (12 U.S.C. 348) is permanently amended to read:

For the purposes of any tax law enacted under authority of the United States or any State, a national bank shall be treated as a bank organized and existing under the laws of the State or other jurisdiction within which its principal office is located. In removing all restrictions on the states with respect to the imposition of taxes on national banks, Congress was aware of the possible ramitications that such action would have on national bank structure and operation. For that reason, it directed the Board to study the probable impact on the banking systems, as well as the other economic effects of the changes made in existing law by the permanent amendment.

In connection with this study, a number of legal questions nood to be resolved. One of these is whether the permanent amendment to section 5219 would permit a State other than a State in which a national bank has its principal office to discriminate against that national bank with respect to the imposition of State taxes. It has been suggested that the rationale which permits a State to impose a discriminatory tax on a foreign insurance company would permit a discriminatory tax on a foreign national bank. This memorandum examines the statutory history and case law dealing with State taxation of foreign insurance companies for the purpose of determining whether a legal basis exists that would permit a State to impose à discriminatory tax on a foreign national bank.

For many years, the business of insurance was held not to be subject. to regulation by the Federal Government because the courts had ruled that, even when conducted interstate, insurance was not commerce. However, in 1944 the United States Supreme Court overturned this rule when it held that fire insurance transactions stretching aerosN state lines constituted interstate commerce subject to regulation by Congress under the commerce clause. A careful reading of that deci sion, United States v. South-Eastern Underwriters Association, 322 U.S. 533, 64 S. Ct. 1162, 88 L. Ed. 1440, rehearing denied 323 U.S. 811, 65 S. Ct. 26, 89 L. Ed. 646 (1944), reveals that so long as Congress refrained from enacting laws regulating or taxing insurance companies transacting business across state lines, each State was free to regulate and tax such companies to the extent that such regulation or taxation related to business transactions within the State. Neverthele

was assumed by many that the effect of the South-Eastern decision was to remove from the states all taxing power with respect to insurance business transacted in interstate commerce. In order to allay these fears, Congress enacted the McCarran-Ferguson Act (15 U.S.C. §§ 1011-15) in 1945. Its stated purpose was to make certain that the decision in the South-Eastern case was not to be interpreted as prohibiting the states from regulating and taxing foreign insurance companies doing business in their states.

The McCarran-Ferguson Act provides, in part, as follows:

Section 1011: The Congress declares that the continued regulation and taxation by the several States of the business of insurance is in the public interest, and that silence on the part of the Congress shall not be construed to impose any barrier to the regulation or taxation of such business by the several States.

Section 1012(a): The business of insurance, and every person engaged therein, shall be subject to the laws of the several States which relate to the regulation or taxation of such business. The legislative history of the McCarran-Ferguson Act indicates that some insurance company executives declined to comply with State laws in this field, fearing that if the laws were unconstitutional, they might be exposing themselves not only to civil liability but also to criminal sanctions for misappropriation of company funds. In addition, State insurance officials and other persons who came in contact with State regulatory provisions were uncertain as to the state of the law.

The McCarran-Ferguson Act represented a considered determination by Congress that the public interest would be served best by permitting continued state regulation and taxation of the insurance industry. The House Committee on the Judiciary, commenting on the proposed legislation, declared:

It is not the intention of Congress in the enactment of this legislation to clothe the States with any power to regulate or tax the business of insurance beyond that which they had been held to possess prior to the decision of the United States Supreme Court in the Southeastern Underwriters Association case. Briefly, your committee is of the opinion that we should provide for the continued regulation and taxation of insurance by the States, subject always, however, to the limitations set out in the controlling decisions of the United States Supreme Court, as, for instance, in Allgeyer v. Louisiana (165 U.S. 578), St. Louis Cotton Compress Co. v. Arkansas (260 U.S. 346), and Connecticut General Insurance Co. v. Johnson (303 U.S. 77), which hold, inter alia, that a State does not have power to tax contracts of insurance or reinsurance entered into outside its jurisdiction by individuals or corporations resident or domiciled therein covering risks within the State or to regulate such transactions in any way. (1945 U.S. Code Congressional Service, pp. 671-72)

In Prudential Insurance Company v. Benjamin, 328 U.S. 408, 66 S.Ct. 1142, 90 L.Ed. 1342 (1946), an insurance company challenged the constitutionality of the McCarran-Ferguson Act. The case involved the right of South Carolina to levy a tax which was to be paid annually by foreign insurance companies as a condition of receiving a certificate of authority to carry on the business of insurance within the State.

The tax amounted to three per cent of the aggregate of premiums received from business done in South Carolina, without reference to its interstate or local character. No similar tax was required of domestic corporations. The Supreme Court, partially in reliance upon the McCarran-Ferguson Act, upheld the tax. The Court reasoned that in passing the Act, Congress intended and, in fact, declared that uniformity of regulation and of State taxation were not required with respect to the business of insurance. The Court went on to point out that while certain state taxes would have been discriminatory and hence invalid in the absence of the McCarran-Ferguson Act, that Act represented a determination on the part of Congress that such taxes did not place a sufficient burden on the interstate insurance business to warrant protection by Congress under the commerce clause. The Court, in Prudential, dwelt at some length on the fact that, with respect to the regulation of the insurance business by the individual States, Congress' power under the commerce clause had not lain dormant but had been exercised through the McCarranFerguson Act. In effect, the court was saying that Congress, acting in concert with the individual States, had sanctioned the local taxation of the insurance business, irrespective of the effect such taxation would have on the interstate aspects of the business.

The Court also noted and was obviously influenced by the fact that Prudential had paid the tax for a number of years prior to the SouthEastern decision and that payment of the tax could not have been excessively burdensome, in view of the fact that Prudential throughout this period competed effectively with local insurance companies. which were not subject to the tax.

The motivation behind Congressional enactment of the McCarranFerguson Act, according to the Court in Prudential, was to:

give support to the existing and future state systems for regulating and taxing the business of insurance. This was done in two ways. One was by removing obstructions which might be thought to flow from its [Congress] own power, whether dormant or exercised, except as otherwise expressly provided in the Act itself or in the future legislation. The other was by declaring expressly and affirmatively that continued state regulation and taxation of this business [the insurance business] is in the public interest and that the business and all who engage in it "shall be subject to" the laws of the several states in these respects (p. 1155).

The Court also noted that Congress had:

clearly put the full weight of its power behind existing and future state legislation to sustain it from any attack under the commerce clause to whatever extent this may be done with the force of that power behind it, subject only to the exceptions expressly provided for (p. 1155).

Prudential had argued that the commerce clause in and of itself prohibited discriminatory State taxation of interstate commerce. However, Justice Rutledge, in summarizing Congress' power under the commerce clause, concluded that Congress had the power -

not only to promote but also to prohibit interstate commerce, as it has done frequently and for a great variety of reasons. That power ́commerce) does not run down a one-way street or one of Larromy fixed dimension. Congress may keep the way o

confine it broadly or closely, or close it entirely, subject only to the restrictions placed upon its authority by other constitutional provisions and the requirement that it shall not invade the domains of action reserved exclusively for the states (p. 1157). While most of the Court's opinion was concerned with the commerce clause, some consideration was given to the due-process and equalprotection clauses of the Fourteenth Amendment. Prudential argued that the South Carolina tax violated both of these constitutional provisions. Even though the Court summarily dismissed this argument by Prudential, the language of the House Committee on the Judiciary quoted earlier should be kept in mind. The Committee there indicated that while the McCarran-Ferguson Act was enacted to permit the continued regulation and taxation of the insurance industry by the individual States, such activity was to be carried out only within the existing framework of decisions like Allgeyer, St. Louis Cotton Compress, and Connecticut General Life Insurance. These cases had detailed the parameters of a State's power to tax contracts of insurance or reinsurance entered into outside its jurisdiction. Congress, in effect, had provided that State taxation of insurance would be held invalid unless there was sufficient nexus or connection, in fact, between the taxed business and the taxing State.

The question of contacts between the taxing State and the business being taxed was discussed in State Board of Insurance v. Todd Shipyards Corp., 370 U.S. 451, 82 S. Ct. 1380 (1962). That case involved a suit by Todd Shipyards against the Texas State Board of Insurance to recover taxes paid under protest by Todd on premiums paid out of State on insurance purchased out of State. The Court found the following facts:

The insurance transactions involved in the present litigation take place entirely outside Texas. The insurance, which is principally insurance against loss or liability arising from damage to property, is negotiated and paid for outside Texas. The policies are issued outside Texas. All losses arising under the policies are are adjusted and paid outside Texas. The insurers are not licensed to do business in Texas, have no office or place of business in Texas, do not solicit business in Texas, have no agents in Texas, and do not investigate risks or claims in Texas.

The insured is not a domiciliary of Texas but a New York corporation doing business in Texas. Losses under the policies are payable not to Texas residents but to the insured at its principal office in New York City (p. 1383).

Based on the above set of facts, the Court was obliged to hold the Texas tax invalid as a violation of the due-process clause, in that the only connection between the State of Texas and the insurance transactions sought to be taxed was that the property covered by the insurance was physically located within the State of Texas. Justice Douglas, in Todd, emphasized that the history of the McCarranFerguson Act contained an "explicit, unequivocal statement" that Allgeyer, St. Louis Cotton Compress and Connecticut General Life Insurance had not been "displaced" by the McCarran-Ferguson Act. The importance of this statement lies in the fact that while uniformity of State taxation was abnegated by the McCarran-Ferguson Act, due process and equal protection still constituted viable checks on a State's taxing power.

The California Supreme Court, in discussing the McCarran-Forguson Act in People vs. United National Life Insurance Company, 58 Cal. Rptr. 599, 427 P. 2d 199 (1967), pointed out that-

The McCarran-Ferguson Act, while validating State power to regulate and tax in respect to the commerce clause, did not purport to circumscribe such power in the light of the due-process clause.

That statement by the Supreme Court of California is a reaffirmation of what has been said a number of times already in this memorandum. That is, while uniformity may not exist in view of the fact that Congress in the McCarran-Ferguson Act has specifically allowed the individual States to regulate and tax the business of insurance, nothing in that act purports to permit discrimination in the imposition of State taxes nor does the act attempt in any way to circumscribe or curtail the right of an insurance company to challenge a State tax imposed upon it as a violation of the due-process and equal-protection clauses of the Fourteenth Amendment of the Constitution.

In summary, since the contacts between the State of South Carolina and the Prudential contracts were significant, a tax levied upon premiums received by Prudential from business done in South Carolina was upheld. However, in Todd, the absence of significant contacts justified the Court in invalidating the Texas tax as a violation of the due-process clause. The McCarran-Ferguson Act and the Prudential case go no further than affirming the right of a State to collect a tax on business conducted within its boundaries. Neither the statute nor the case specifically can be interpreted as sanctioning the imposition of a discriminatory State tax.

Having reached this conclusion with respect to the McCarranFerguson Act, it is still necessary to focus on the National Bank Tax Act itself to determine the reasons for its enactment, and whether its language, standing alone, would permit a State to discriminate against a foreign national bank. The legislative history of the National Bank Tax Act details clearly a desire on the part of Congress to permit a State to impose the same taxes on a national bank as it now imposes or will impose in the future on a State bank. The report of the House Committee on Banking and Currency indicated that the National Bank Tax Act says "that national banks shall be subject to the same taxation as State banks and it means exactly what it says" (emphasis added). Somewhat along the same lines, the Senate Banking and Currency Committee indicated that:

There is no longer any justification for Congress continuing to grant national banks immunities from State taxation which are not afforded State banks.

The Conference Committee, in summarizing the effect of the permanent amendment to section 5219 of the revised statutes, indicated that on January 1, 1972:

Any State will be free to impose taxes on income derived within its borders by the operations of a bank having its principal office in a different State, regardless of whether the foreign bank is State or National. This has always been the law with respect to State

banks.

At the outset, it was indicated that the reason for this memorandum was the concern expressed by some that section 5219 would permit 4imposition of discriminatory taxes on foreign national banka via a