Evaluation of the Russian trade levy under the constitutionality test articulated by US case law / Оценка российского торгового сбора на основании критериев конституционности, сформулированных американским прецедентным правом

Братко Татьяна Дмитриевна ORCID: 0000-0003-4682-573X преподаватель Департамента международного и публичного права Федерального государственного образовательного бюджетного учреждения высшего образования «Финансовый университет при Правительстве Российской Федерации» (Финансовый университет) 105187, Россия, г. Москва, ул. Щербаковская, 38, каб. 805 Bratko Tatiana Dmitrievna Lecturer of the Department of International Law and Public Law of the Federal State Educational Budgetary Institution of Higher Education "Financial University under the Government of the Russian Federation" (Financial University) 105187, Russia, g. Moscow, ul. Shcherbakovskaya, 38, kab. 805 bratkotatiana@gmail.com Другие публикации этого автора

I. Introduction

The interplay between legislative and constitutional provisions is contentious and often raises concerns. In many cases the Russian tax laws are held to conflict with the Constitution of the Russian Federation.

Critics question constitutionality of the Russian trade levy. The Constitutional Court of the Russian Federation has already examined several aspects of the Russian Tax Code concerning the trade levy. As the Constitutional Court of the Russian Federation concluded in its Ruling of 11 October 2016 (2152-O), the trade levy does not violate the Russian Constitution.

This essay provides the first general analysis of the Russian trade levy in view of the US (United States) legal doctrine. It is focused on whether the trade levy:

1) subjected interregional commerce to a risk of multiple taxation;

2) discriminated against interregional commerce;

3) violated the principle of the unitary national market by burdening interregional competitors.

II. The US judicial criteria of the tax’s constitutionality

In Complete Auto (Complete Auto Transit, Inc. v. Brady, 1977, 430 U.S. 274) the US Supreme Court established a four-prong test for determining when a state tax is valid under the US Constitution’s Commerce Clause. As the US Supreme Court jurisprudence teaches, a state tax imposed on interstate commerce is constitutional if it «... is applied to an activity with a substantial nexus with the taxing State, is fairly apportioned, does not discriminate against interstate commerce, and is fairly related to the services provided» (Complete Auto Transit, Inc. v. Brady, 1977, 430 U.S. 279).

Under the first prong of the test, a state tax must be «applied to an activity with a substantial nexus with the taxing State» (Complete Auto Transit, Inc. v. Brady, 1977, 430 U.S. 279). Until Wayfair (South Dakota v. Wayfair Inc., 2018, 585 U.S. ___), the constitutionally required nexus between the taxing state and the activity subject to tax was interpreted as establishing the physical presence rule (for a rich overview, see ^{[1; 2]}). By 21 June 2018, the US Supreme Court changed its opinion about the nexus and decided that the nexus is sufficient when the taxpayer or collector avails himself of the substantial privilege of carrying on business in the taxing state even without physical presence there (South Dakota v. Wayfair Inc., 2018, 585 U.S. ___).

The second prong in Complete Auto requires to show that the state tax is duly apportioned, i.e., that the state does not attempt to tax any interstate activities carried on outside its borders. The state may impose a tax on what happens within its borders (for earlier opinions in a related context, see, e.g., Western Live Stock v. Bureau of Revenue, 1938, 303 U.S. 250; J. D. Adams Mfg. Co. v. Storen, 1938, 304 U.S. 307; McGoldrick v. Berwind-White Coal Mining Co., 1940, 309 U.S. 33; McLeod v. J. E. Dilworth Co., 1944, 322 U.S. 327; Nippert v. Richmond, 1946, 327 U.S. 416; Memphis Nat. Gas Co. v. Stone, 1948, 335 U.S. 80). Thus, the apportionment requirement aims to prevent certain forms of multiple taxation. Each taxpayer shall only pay a tax on an activity or income attributed to the taxing state. This general principle is well established and long recognised (see, e.g., Postal Telegraph Cable Co. v. Adams, 1895, 155 U.S. 688; Atlantic & Pacific Tel. Co. v. Philadelphia, 1903, 190 U.S. 160; St Louis Southwestern Ry. Co. v. Kansas, 1914, 235 U.S. 350; Nashville, Chattanooga & St. Louis Ry. Co. v. Browning, 1940, 310 U.S. 362; Norfolk & W. R. Co. v. Missouri State Tax Comm'n, 1968, 390 U.S. 317; Moorman Mfg. Co. v. Bair, 1978, 437 U.S. 267; Mobil Oil Corp. v. Commissioner of Taxes, 1980, 45 U.S. 425; Oklahoma Tax Comm’n v. Jefferson Lines Inc., 1995, 514 U.S. 175).

The third prong (discrimination prong) of the Complete Auto test demands that the state impose no greater tax burden on interstate commerce than it imposes on intrastate commerce. This prong precludes the taxing states from supporting in-state businesses in competition with out-of-state businesses (on the wider issue of tax discrimination, see generally ^{[3, p. 4, 6; 4; 5; 6; 7; 8; 9]}).

The Complete Auto’s fourth prong asks whether the tax is fairly related to services which the taxing state provides to the benefit of taxpayers. The taxing body, by supplying public services such as police and fire protection, seeks to satisfy taxpayers’ needs and preferences (for an endless economic discussion, see ^{[10, p.18–21]}). Actually, «taxes are what we pay for civilized society» (Compania General de Tabacos v. Collector, 1927, 275 U.S. 87). But the tax need not be limited to the cost of the services provided by the taxing state, according to the Complete Auto’s fourth prong (see, in this respect, ^[11]). The measure of the tax must be reasonably related to the extent of the taxpayer’s contact with the taxing state (Commonwealth Edison Co. v. Montana, 1981, 453 U.S. 609), or, in other words, to the presence and activities of the taxpayer within the state (see, e.g., D. H. Holmes Co., Ltd. v. McNamara, 1988, 486 U.S. 24; Goldberg v. Sweet, 1989, 488 U.S. 252). The aim of this test is to ensure that the tax does not burden persons who do not benefit from services provided by the taxing state.

In our view, Complete Auto laid down fundamental criteria that reflect basic values implicit in the concepts of constitutional federalism, decentralization of powers, multilevel government and fairness. These are the concepts common to the constitutions of various States, including Russia. Accordingly, Complete Auto test developed by the US Supreme Court may be applied not only to regional but to all taxes collected at all levels of government in the Russian Federation (federal, regional and municipal). From our perspective, the US Supreme Court created a universal approach that can determine when a:

1) rational relationship exists between the taxable activity and the taxing unit;

2) sub-federal tax violates the principle of the unitary national market by unreasonably burdening competition and discriminating against cross-border commerce.

III. Application of the Complete Autofour-prong test for judging the constitutionality of the Russian trade levy

The Russian trade levy falls within the general definition of «tax» found in Article 8 of the Russian Tax Code. A tax, as stated in Article 8, is a charge imposed upon persons for public purposes of federal, regional or municipal government. Regional and municipal authorities shall establish trade levies to pay the cost of government without regard to whether the person subject to the levy receives a special benefit not enjoyed by others (the Russian Tax Code, Chapter 33, Arts. 410-418). Furthermore, the trade levy is fully consistent with the definition of a levy provided in Article 8 of the Russian Tax Code and, therefore, does not constitute an illegal exaction.

Under the law of Russia, a «trade levy» is a charge, similar to a sub-federal tax, imposed (currently by Moscow only) in the same manner as taxes for regional and municipal purposes. The trade levy forms a part of income tax scheme created by the Russian Federation. Sub-federal law determines the amount of the trade levy. But federal law determines the statutory income tax scheme as a whole and the allocation of tax revenue among units of government.

Since the Complete Auto test applicable to sub-federal taxes reflects the basic federalism doctrines, which are common to the Russian jurisprudence, and encompasses the requirement of protecting the national common market that is also familiar to the Russian law (Article 8 of the Russian Constitution), the Russian trade levy may be evaluated under this four-prong test. In our view, the Russian trade levy as a part of the Russian income tax scheme satisfies three prongs of the Complete Auto test.

The activity subject to the trade levy has a substantial nexus with the taxing unit, Moscow (Moscow is one of the many regions that have joined together to form the Russian Federation). Arts. 411-413 of the Russian Tax Code provide that the activity being taxed with a trade levy is the activity of using immovable or movable property for trade purposes in the territory of Moscow. There can be no doubt that the use of property within Moscow has a substantial nexus with this region. Consequently, the first prong of the test is satisfied.

The Russian trade levy is not invalid under the second prong of the test, the apportionment provision, because the taxable activity occurs in the taxing unit (Moscow) and no other region. There is no issue of unfair apportionment.

Further, the Russian trade levy also comports with the fair relation requirement of the Complete Auto test. The levy funds region-provided services that promote general welfare and facilitate trade carried on by the levy payer, including police and fire protection for the payer’s property, as well as mass transit and public roads for use by the payer’s customers. Having chosen to operate in Moscow, the trade levy payer enjoys the benefits of such services. Thus, the trade levy is fairly related to the services provided by the taxing unit (for a wider discussion, see ^[12]).

The last prong of the Complete Auto test is whether the Russian trade levy discriminates against interregional commerce in violation of the Constitution. We need to consider this question in some detail.

From our point of view, the trade levy creates a substantial risk of double taxation on trade income. Business income pursuant to Article 346.14 of the Russian Tax Code is taxed within the «simplified taxation system». The activity subject to trade levy is the use of property for trade purposes in the territory of Moscow – in other words, the implied income derived from the immovable and movable property, if the use of property constitutes a part of the payer’s regular trade or business operations. The portion of the trade income therefore is subjected to double taxation since a businessman pays the trade levy and the tax within the simplified taxation system (STS tax) upon his business earnings from immovable and movable property in Moscow.

In order to prevent double taxation on that trade income the taxpayer, a Moscow resident doing business in Moscow, can take a credit against the STS tax by the amount of the trade levy paid to Moscow (Article 346.21 Section 8 of the Russian Tax Code). The tax credit for the sum of the trade levy is designed to avoid double taxation of the regional resident’s income derived from the use of property for trade purposes. A non-resident taxpayer doing business in Moscow is not entitled to the tax credit for the sum of the trade levy.

The trade levy duplicates not only the STS tax, but also the profits tax for companies and income tax for individuals imposed under the Russian Tax Code and thus results in double taxation of the non-resident’s trade income derived from the immovable and movable property in Moscow (Article 346.21 Section 8, Article 286 Section 10 and Article 225 Section 5 of the Russian Tax Code). Such taxation may increase the cost of goods sold by non-residents doing business in Moscow.

To the extent that residents of the region, which establishes the trade levy, can avoid the payment of the trade levy, non-residents are subjected to an increased risk of being placed at a competitive disadvantage. In our view, this tax treatment encourages more taxpayers to carry on business in one region and leads to economic Balkanisation and destruction of the national common market in violation of the Russian Constitution’s Arts. 8 and 74. It is widely known that the Commerce Clause of the US Constitution also prohibits states from balkanising into separate economic units (Baldwin v. G.A.F. Seelig, Inc., 1935, 294 U.S. 511; H. P. Hood & Sons, Inc. v. Du Mond, 1949, 336 U.S. 525; Bacchus Imports, Ltd. v. Dias, 1984, 468 U.S. 263), since economic Balkanisation plagues relations among the states in the federation (Hughes v. Oklahoma, 1979, 441 U.S. 322).

From our point of view, the Russian trade levy produces a discriminatory effect on interregional commerce. There is a disparity in tax treatment between residents and non-residents of the region, which imposes the trade levy. The burden of the trade levy falls upon residents and non-residents. But that burden is removed from regional residents through the tax credit mechanism contained in Article 346.21 Section 8, Article 286 Section 10 and Article 225 Section 5 of the Russian Tax Code. In computing the amount of the income tax, only a regional resident may deduct the sum of the trade levy from income taxes.

The sum of the trade levy, as we mentioned above, represents income tax credit for the resident business, but for the non-resident business of the region that establishes the trade levy. So, in our opinion, the tax credit for the sum of the trade levy, as applied to non-residents of the region, which imposes the trade levy, has the effect of discriminating against interregional commerce to the direct commercial advantage of local business, since:

1) it creates disparity in tax treatment between residents and non-residents (by, in particular, providing a direct commercial advantage to Moscow-based businessmen over non-Moscow-based businessmen);

2) the objects (residents and non-residents) of the disparate tax treatment are similarly situated;

3) there are no substantial reasons for the difference in tax treatment.

This disparity, which involves giving local businesses a tax credit for the sum of the trade levy not available to interregional businesses, constitutes facial discrimination. Discriminatory tax burdens on the non-residents being inconsistent with the constitutional policy of free trade and competition violate Arts. 8 and 74 of the Russian Constitution.

The Russian income tax scheme discriminates on the basis of residency and, like the Maryland’s tax scheme analysed in Wynne (Comptroller of Treasury of Md. v. Wynne, 2015, 575 U.S. ___ ), operates as tariffs, which are the «paradigmatic example of a law discriminating against interstate commerce» (West Lynn Creamery, Inc. v. Healy, 1994, 512 U.S. 186). The critical point is that the economic burden of the trade levy falls upon regional non-residents only, and the total tax burden on regional non-resident’s income is higher than on regional resident’s income.

Hence we think that the trade levy as a part of the Russian trade income tax scheme does not satisfy the discrimination prong of the Complete Auto test.

IV. How to cure the discrimination in accordance with global practice

Either a repeal of the trade levy or an expansion of the income tax credit to provide the interregional business with a credit against the income tax for the sum of the trade levy would cure the discrimination.

The tax credit provision for the interregional businesses may be an appropriate legislative response to the problem of unconstitutional facial discrimination on the basis of residency. This response is consistent with the applicable Russian tax law principles and foreign practice of avoiding multiple taxation.

A tax on income or property shall be imposed by the state of the taxpayer’s residence (hereafter «state of residence») or the state where the taxable income or property is earned or located (hereafter «state of source»). See, e.g., ^{[13, p. 7–9]}. The income derived from sources within the state of source may be taxed under its laws irrespective of the residence of the taxpayer. According to the long established and widely accepted tax doctrine, the state of residence usually yields to the state of source to prevent double taxation. Notably, international, national and subnational practice does not permit double taxation: a taxing authority that levies income taxes usually provides a credit for similar taxes paid to another jurisdiction (for an overview in a related context, see ^{[14, p. 159–161; 13, p. 7; 15, p. 165–167; 16, p. 31–64]}). For example, the principle that residence yields to source is applied in the income and property tax context to avoid multiple taxation in the US (Mobil Oil Corp. v. Commissioner of Taxes, 1980, 445 U.S. 425; Ott v. Mississippi Valley Barge Line Co., 1949, 336 U.S. 169).

The state’s power to tax on the basis of source derives from the state’s general authority to regulate economic activities within its boundaries and to defray the costs of providing privileges non-residents enjoy under its constitution and laws and protection they receive from the state (Shaffer v. Carter, 1920, 252 U.S. 37). Moreover, if a state abstains from taxing on the basis of source and excludes from taxation commercial activities of non-residents while taxing residents’ activities in full, such taxation imposes greater burdens on residents’ activities than on competing non-residents’ activities and discriminates against residents (for a careful analysis in international tax law, see ^{[16, p. 36–37]}).

Regional residents pay Russian STS tax for all income earned regardless of source. The region of residence actually receives tax revenue from its residents who earn income from interregional and intraregional commerce (Arts. 346.12 and 346.13 of the Russian Tax Code, Article 56 Section 2 of the Russian Budgetary Code).

Regional residents and non-residents who earn income from regional sources, i.e., income derived from the use of property in the taxing region, must pay the trade levy on that income under Article 411 Section 1 and 412 of the Russian Tax Code. For example, Moscow as a region of source establishes the trade levy and actually receives tax revenue from its non-residents.

Both the region of residence and the region of source, Moscow, today receive tax revenue from the non-Moscow-based businessman who earns income from the use of property for trade purposes in the territory of Moscow. Such a businessman is taxed twice on that trade income. Pursuant to the widely accepted source-trumps-residence principle, the region of residence yields to the region of source. In our view, non-residents of the region that imposes the trade levy must be allowed to deduct the trade levy from their income taxes (the STS tax, the profits tax for companies or income tax for individuals). This rule is necessary to avoid multiple taxation on trade income.

V. Conclusion

To sum up our position briefly, we conclude that the Russian trade income tax scheme failed to pass the non-discrimination part of the Complete Auto test. From our perspective, the trade levy as a part of the Russian income tax scheme results in unconstitutional discriminatory treatment of regional residents and non-residents, destructs the national common market and promotes economic Balkanisation by burdening interregional competitors.

In our view, Complete Auto test developed by the US Supreme Court may be applied to taxes and levies not only in Russia, but also in other Federations throughout the world which promote basic values implicit in the concepts of constitutional federalism, decentralization of powers, multilevel government and fairness. Using this analytical framework, a taxpayer who seeks to show disparate treatment must argue that a tax or levy does not meet the universal criteria initially laid down in Complete Auto. Such an uncommon approach gives new opportunities for taxpayers to test the constitutionality of a tax or levy in the Russian Federation and worldwide.