Dennis Rimkunas is of counsel with Jones Day, New York, and he can be reached at drimkunas@jonesday.com. Brendan Ballou is an associate with Jones Day, Washington, and he can be reached at bballou@jonesday.com.
The views set forth in this article are the personal views of the authors and do not necessarily reflect the opinions of Jones Day, its clients, or any other organization with which the authors are associated.
In this inaugural installment of Rimkunas Ruminates, the authors review a June decision by the New York Court of Appeals and describe how New York courts have historically interpreted tax exclusions and tax exemptions — and the admitted flaws in that framework.
‘In New York, the Taxpayer Always Loses’
In June the New York Court of Appeals issued a decision that will change the way that state courts and administrative bodies interpret tax statutes. The court held that statutes concerning tax exclusions (in which the property or income at issue is statutorily excluded from taxation) and tax exemptions (in which the property or income is normally taxable, but somehow excused) are all to be interpreted against the taxpayer. This change redounds to the benefit of the New York State Department of Taxation and Finance, and against New York taxpayers.
With respect, the authors posit that this decision was incorrect, both as a matter of law and policy. In this article, the authors describe how New York courts have historically interpreted tax exclusions and tax exemptions and the admitted flaws in that framework. The article describes the court’s decision and reasoning, and why, in the opinion of the authors, that decision was incorrect.
New York’s Treatment of Tax Exclusions and Tax Exemptions
Historically, New York distinguished between tax exclusions and tax exemptions. The boundary separating the two was not always clear, an issue we address later in this article. In general, however, an item excluded from taxation is “definitionally excepted,” while an item exempted from taxation “meet[s] the statutory conditions precedent to regulation, but is, as an act of legislative grace, nonetheless excepted.”1
As a general matter, “a statute which levies a tax is to be construed most strongly against the government and in favor of the citizen,”2 and such is the case with tax exclusions. That is, “in interpreting a tax statute which is exclusionary in nature, we must construe the statute most strongly against the government.”3 By contrast, tax exemptions “are strictly construed. If ambiguity or uncertainty occurs, all doubt must be resolved against the exemption.”4 New York is far from alone in this distinction: Other states similarly interpret tax exclusions in favor of the taxpayer, and tax exemptions in favor of the taxing authority.5
Admittedly, there were at least three flaws in New York’s framework.
First, the distinction between exclusions and exemptions was never precise. A federal court in Pennsylvania, where the state law similarly distinguishes between exclusions and exemptions, described the difference better than the New York courts have when it wrote:
Tax exemptions are items which the tax payer is entitled to excuse from the operation of a tax and, as such, are to be strictly construed against the taxpayer. Tax exclusions, on the other hand, are items which were not intended to be taxed in the first place.6
Even there, however, the distinction between items that a taxpayer is “entitled to excuse” and items that “were not intended to be taxed in the first place” is imprecise. The distinction between the two is not obvious in all cases.
Second, authorities interpreting tax exclusion and exemption statutes often took a formalistic approach to determine whether the tax statutes at issue concerned exclusions or exemptions. For instance, the concurrence in Wegmans — the case at issue in this article — cited both New York Life Insurance, concerning an exclusion from the sales tax for the sale of information services, and Engle, concerning an exemption from the property tax for buildings used for religious purposes.7 The statute at issue in New York Life Insurance specifically used the term “exclude,” while the statute at issue in Engle specifically used the term “exempt.”8 Given that the exclusion in New York Life Insurance could arguably be described as an exemption, while the exemption in Engle could arguably be described as an exclusion, it appears that courts were influenced in part by how statutes described themselves, in addition to the actual operation of the taxes at issue.
Third, New York case law never made clear why tax exclusions and tax exemptions should be treated differently. In Matter of Grace, the decision purportedly establishing the differential treatment of exclusions and exemptions, the court of appeals wrote that “an exemption is not a matter of right but is allowed only as a matter of legislative grace.”9 This may be true enough, but an exclusion from taxation is also a matter of legislative grace. In a precursor to Grace, the court of appeals wrote that “tax exemptions . . . are limitations of sovereignty.”10 This too may be true, although to the extent that the court intended to distinguish exemptions from exclusions in that case, it is unclear how both are not limitations on state sovereignty.
In short, New York’s distinction between tax exclusions and exemptions had meaningful flaws. In Wegmans, the court of appeals recognized some of these flaws, but delivered a conclusion that was arguably incorrect.
Wegmans
In this case, taxpayer Wegmans Food Markets Inc. purchased business reports on competitors’ pricing tactics. As issue was whether Wegmans’ purchase of these reports was subject to tax under New York Tax Law section 1105(c)(1), which taxes the sale of some information services. The administrative law judge hearing the matter denied Wegmans’ petition, and the New York Tax Appeals Tribunal affirmed. The New York State Supreme Court, Appellate Division, reversed and held that the relevant tax law did not apply to Wegmans’ purchases. In doing so, the appellate division noted that “in the event of ambiguity, where, as here, an exclusion rather than an exemption is involved, the statute must be strictly construed in favor of the taxpayer.”11
The New York Court of Appeals granted the commissioner of taxation and finance leave to appeal, and it reversed the decision of the lower court. In so doing, the court of appeals determined that in interpreting both tax exclusions and tax exemptions, “the presumption is in favor of the taxing power.”12
The court made three primary claims in the process of reaching this conclusion.
First, the court argued that the primary case from which New York courts distinguished exclusions and exemptions — Matter of Grace — never actually made that distinction explicit.13 Moreover, a subsequent decision — Matter of Mobil Oil — established a presumption in favor of the taxing power in interpreting tax exceptions.14
Second, the court argued that the distinction between exclusions and exemptions resulted in needless formalism. As an alternative, the court asserted, “we have adopted a functional analysis that affords a singular and workable rule for construing exemptions, exclusions, and deductions, each of which operate to negate the taxpayer’s obligation to pay the otherwise applicable tax.”15
Third, the court held that interpreting exclusions and exemptions in favor of the taxing authority was itself a sensible conclusion. This was so because an exemption is “not a matter of right but is allowed only as a matter of legislative grace.”16 Such is also case with exclusions.
In a blunt concurrence, Justice Stein wrote that “the majority today declares a new rule: in New York, the taxpayer always loses.”17 Stein wrote that whether or not Matter of Grace made explicit the exclusion-exemption distinction, Matter of Grace’s progeny did.18 Moreover, Mobil Oil in turn did not overrule Matter of Grace; indeed, it did not even mention it.19 Finally, Stein argued that the majority’s change, such as it was, in interpreting tax exclusions, was unnecessary for the resolution of the case.20 Stein concluded:
The majority’s declaration that New York taxpayers are now deprived of a protection they have long enjoyed — in a misguided attempt to resolve confusion in the lower courts that never existed — is not only wrong, but completely unnecessary.21
Analysis
With respect, we posit that eliminating the exclusion-exemption distinction removes one of very few advantages that the taxpayers have when taking on a state taxing authority. Moreover, the court’s holding chips away at the fundamental principle that the statute must be interpreted against the taxing authority.
As discussed above, the logical underpinning of interpreting an exclusion against a taxing authority is that the exclusion is beyond the scope of the statute. However, just as the distinction between an exclusion and exemption is not always clear, the distinction between an exclusion and the scope of a tax statute itself is often uncertain. The very act of interpreting a tax statute, or any statute for that matter, requires understanding what it excluded or exempted from its domain.
Essentially, the court shifted the analysis from whether the statute contains an exclusion or an exemption, which would determine against whom the statute is interpreted, to whether the statute itself should be interpreted against the taxpayer. Now any taxpayer argument that a taxing authority’s position is beyond the scope of the statute would have to overcome a counterargument that the taxpayer’s position merely seeks an exclusion from the statute, which would require the statute to be interpreted against the taxpayer. In effect, elimination of the exclusion-exemption distinction in Wegmans will be just as unworkable as the framework that existed before it and will result in just as much formalism. Except now, the taxpayers will find themselves in a much more precarious position.
A better solution would be to interpret both exclusions and exemptions narrowly in favor of the taxpayer. This is consistent with the general directive that “a statute which levies a tax is to be construed most strongly against the government and in favor of the citizen.”22 There is good reason for that directive: Taxpayers require notice of what the tax laws are, and ought not be punished with interest and potential fines for failing to obey laws that they did not understand. Moreover, to the extent that tax laws are supposed not only to raise money but also to shape behavior, those laws ought to be clear to those who must follow them.
Looking forward, tax practitioners should, when confronted with an interpretation of a tax statute, explain that the tax issue concerns an analysis of the statute itself, not any exclusion or exemption from it. But there is cause for concern that the new standard for interpreting exclusions, as articulated in Wegmans, may well absorb the larger rule for interpreting tax statutes generally.
FOOTNOTES
1 La Guardia v. Cavanaugh, 53 N.Y.2d 67, 80 (1981).
2 People ex rel. Mutual Trust Co. of Westchester County v. Miller, 177 N.Y. 51, 57 (1903).
3 American Savings Bank v. State Tax Commission, 103 A.D.2d 963, 964 (N.Y. 1984), rev’d sub nom. on other grounds, American Savings Bank v. State Tax Commission of State of N.Y., 65 N.Y.2d 824 (1985).
4 People v. Brooklyn Garden Apartments, 283 N.Y. 373, 380 (1940) (internal citation omitted).
5 See, e.g., Commonwealth v. Sitkin’s Junk Co., 412 Pa. 132 (Pa. Sup. Ct. 1963); and Crowe v. Bio-Med. Application of Louisiana LLC, 2014-0917 (La. App. 1 Cir. Jun. 3, 2016).
6 In re Twisteroo Soft Pretzel Bakeries Inc., 21 B.R. 665, 667 (Bankr. E.D. Pa. 1982).
7 Wegmans Food Markets Inc. v. Tax Appeals Tribunal of State, No. 56, 2019 WL 2618068, at *2 (N.Y. June 27, 2019) (Stein, J., concurring) (citing New York Life Insurance Co. v. State Tax Commission, 80 A.D.2d 675 aff’d sub nom. Metropolitan Life Insurance Co. v. State Tax Commission, 55 N.Y.2d 758 (1981); and Engle v. Talarico, 33 N.Y.2d 237 (1973)).
8 N.Y. Tax Law section 1105 (1981); and N.Y. Real Property Tax Law section 467 (1970).
9 Grace v. New York State Tax Commission, 37 N.Y.2d 193, 195 (1975).
10 Brooklyn Garden Apartments, 283 N.Y. 373, 380.
11 Wegmans Food Markets Inc. v. N.Y. State Tax Appeals Tribunal, 155 A.D.3d 1352, 1355 (N.Y. App. Div. 2017).
12 Wegmans, No. 56, 2019 WL 2618068, at *2 (quoting Matter of Mobil Oil Corp., 58 N.Y.2d 95, 99 (1983)).
13 Id. at *2.
14 Id.
15 Id. at *3.
16 Id. (quoting Grace, 37 N.Y.2d 193, 197).
17 Id. at *5 (Stein, J., concurring).
18 Id. at *6.
19 Id. at *7.
20 Id. at *8.
21 Id.
22 Mutual Trust. Co., 177 N.Y. 51, 57.
END FOOTNOTES