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Commonwealth v. Interstate Gas Supply, Inc.

Supreme Court of Kentucky

March 22, 2018



          COUNSEL FOR APPELLANT: Douglas M. Dowell Kentucky Department of Revenue Office of Legal Services for Revenue

          COUNSEL FOR APPELLEE: Timothy Joseph Eifler Stephen A. Sherman Stoll Keenon Ogden PLLC


          HUGHES, JUSTICE.

         Section 170 of the Kentucky Constitution provides in part that "[t]here shall be exempt from taxation ... institutions of purely public charity." This case requires us once again to consider the scope of this "public charity" exemption, and more specifically to decide whether it relieves a qualifying charitable institution from the use tax imposed by Kentucky Revised Statute (KRS) 139.310. The Finance and Administration Cabinet's Department of Revenue (the Department), the Board of Tax Appeals, and the Franklin Circuit Court all concluded the § 170 constitutional exemption speaks only to ad valorem (property) taxes, but the Court of Appeals disagreed. We granted the Department's motion for discretionary review, and for the following reasons hold the Department, the Board of Tax Appeals, and the circuit court correctly concluded that Ky. Const. § 170 does not exempt a "public charity" institution from the use tax imposed by KRS 139.310.


         According to the parties' stipulation, the taxpayer in this case, Tri-State Healthcare Laundry, Inc., is a joint-cooperative laundry association located in Edgewood, Kenton County, Kentucky. Tri-State was formed by, is owned by, and serves the laundry needs of three charitable hospitals in the Kenton County/Greater Cincinnati metropolitan area. For reasons not included in the stipulation or otherwise explained, Tri-State is not registered with the Internal Revenue Service as an I.R.C. (Internal Revenue Code) § 501(c)(3) corporation and does not qualify for a charitable exemption from the federal income tax.[1]Because Tri-State is not a § 501(c)(3) organization, it does not qualify for the exemption from sales and use taxes provided to local non-profits under KRS 139.495. Nor does it otherwise qualify for any of the specific sales and use tax exemptions provided in KRS 139.470(1)-(23). Since 1998, however, the Department and its predecessors have deemed Tri-State an "institution of purely public charity" under Ky. Const. § 170 and have accordingly exempted it from ad valorem taxation. Relying on this state-recognized "public charity" status, Tri-State now seeks exemption from the Kentucky use tax for its natural gas purchases.[2]

         Tri-State uses natural gas in the operation of its laundry business, and during the period pertinent to this case, it obtained that gas from Appellee Interstate Gas Supply, Inc. (IGS), an Ohio corporation headquartered in Dublin, Ohio. IGS's business includes the retail sale of natural gas to customers in northern Kentucky, such as Tri-State, and it has duly registered the Kentucky portion of its business with the Department. KRS 139.340 and 139.390. In accord with KRS 139.340, IGS collects use taxes on its natural gas sales to Kentuckians and remits the taxes to the Department.

         This case began in October 2009 when IGS (the tax collector and remitter) applied to the Department on behalf of Tri-State (the taxpayer) for a refund of all Kentucky use taxes Tri-State paid through IGS from September 1, 2005 to August 31, 2009, a sum exceeding $99, 000, plus the appropriate interest. In support of their refund claim, IGS and Tri-State advanced two theories. First, they maintained that Tri-State's recognized status as an "institution of purely public charity" exempted it under § 170 from all revenue-raising taxes (use tax included), not just ad valorem taxes. Second, citing Commonwealth ex rel. Luckett v. City of Elizabethtown, 435 S.W.2d 78 (Ky. 1968), they maintained that the use tax, regardless of its name and the fact that use taxes are usually viewed as excise taxes rather than property taxes, operates so like a property tax as to bring it within the § 170 charitable institution exemption even if that constitutional provision applies only to property taxes.

         In its August 2010 Final Ruling, the Department denied the IGS/Tri-State refund claim and explained that in its view, even though Tri-State has been deemed a "purely public charity" for the purposes of § 170, both theories advanced by the claimants have been rejected. The Department reasoned that this Court explicitly rejected the first theory and implicitly rejected the second theory in Children's Psych. Hosp. of N. Kentucky, Inc. v. Revenue Cabinet, 989 S.W.2d 583 (Ky. 1999). In that case, the Court held that the § 170 exemption for institutions of purely public charity was addressed to ad valorem taxes only and so did not apply to the 1994 "Healthcare Provider Tax" on the state's hospitals. This holding, in the Department's view, amounted to an explicit rejection of the claimants' theory that Tri-State is exempt from all revenue-raising taxes, and was implicitly a rejection of the ruling in City of Elizabethtown that § 170 exemptions could extend to use taxes. Even if City of Elizabethtown remained viable after Children's Psych. Hosp., the Department further explained, the City of Elizabethtown case was distinguishable in that it concerned a different § 170 exemption, i.e., not the "public charity" exemption at issue here, but rather the exemption for "public property used for public purposes."[3]

         Undeterred, IGS and Tri-State appealed the Department's ruling to the Kentucky Board of Tax Appeals. They relied on the same two theories the Department rejected and, for essentially the same reasons, the Board rejected them as well. Likewise, the Franklin Circuit Court, upon review of the Board's decision, concluded that under Children's Psych. Hosp., the § 170 exemption for public charities "only exempts institutions of purely public charity from the payment of property taxes. Since the use tax is not a property tax, the exemption does not apply."

         In the Court of Appeals, the claimants' perseverance finally paid off. Although the appellate panel concluded that Children's Psych. Hosp. had undone an eighty-year-old construction of the constitutional exemption for "public charities"[4] by confining that exemption to property taxes, it found merit in the claimants' alternative theory. Having discussed City of Elizabethtown, the panel noted that "[t]he current law in Kentucky [as expressed in City of Elizabethtown] is that the use tax imposed under KRS 139.310 is similar enough to an ad valorem tax to render its enforcement on governmental entities unconstitutional under Section 170." The panel saw no reason "why the rule should be applied differently with respect to institutions of purely public charity." Finding that Tri-State had, in effect, been taxed in violation of § 170, the Court of Appeals reversed the circuit court.

         We granted the Department's motion for discretionary review to consider the viability and scope of City of Elizabethtown. Not surprisingly, IGS and Tri-State have asked, as an alternative ground of affirmance, that we also consider the viability and scope of Children's Psych. Hosp. The issues having been presented as pure questions of law arising from stipulated facts, our standard of review is de novo. Freeman v. St. Andrew Orthodox Church, Inc., 294 S.W.3d 425 (Ky. 2009). We begin our analysis with consideration of the specific tax at issue, namely the use tax.


         I. Section 170 of the Kentucky Constitution Provides for Exemptions from Property Taxes Only

         A. The Kentucky Use Tax

         Use taxes are commonly imposed in conjunction with sales taxes and are intended to counteract any incentive the sales tax might give to local consumers to shop in another jurisdiction where the sales tax is less or nonexistent. See Henneford v. Silas Mason Co., 300 U.S. 577, 579-81 (1937) (describing the then sales/use tax regime of Washington State). In very general terms, use taxes achieve that purpose in two steps. The first step is the imposition of a broad tax, at the sales tax rate, on the "use of or the "privilege of using" within the taxing jurisdiction tangible personal property purchased anywhere. That liability falls on the "user" of the property. The sweeping liability thus created is then just as dramatically narrowed in the second step, by provisions that give use tax credit (or exemption) for sales tax already paid, within the jurisdiction or without, on the subject property. The upshot is a tax supplemental to the retail sales tax on personal property used-for consumption, not for resale-inside the jurisdiction even though purchased outside it. See Nat'l Geographic Soc. v. California Bd. of Equalization, 430 U.S. 551, 555 (1977) (addressing aspects of California's then version of the regime and noting that, generally, "States that impose sales taxes also impose a corollary use tax on tangible property bought out of State to protect sales tax revenues and put local retailers subject to the sales tax on a competitive parity with out-of-state retailers exempt from the sales tax.").[5]

         Kentucky's statutes fit this pattern.[6] "The sales and use tax laws are integrated elements of a taxing program that is designed to reach all transactions in which tangible property is sold inside or outside of Kentucky for storage, use, or consumption within Kentucky." Revenue Cabinet v. Lazarus, Inc., 49 S.W.3d 172, 175 (Ky. 2001) (citing Genex/London, Inc. v. Ky. Bd. of Tax Appeals, 622 S.W.2d 499, 506 (Ky. 1981)). The use tax is "a backstop to the sales tax because it ensures that transactions in other states are treated just as if they had taken place in this state and been subjected to the sales tax." Lazarus, 49 S.W.3d at 175 (citing Commonwealth v. Lee's Ford Dock, Inc., 551 S.W.2d 236 (Ky. 1977)). Sales and use taxes generally are classified as excise taxes because they are "not a burden laid directly upon persons or property" but rather charges imposed on the sale and/or use of goods to raise revenue. State Tax Comm'n v. Hughes Drug Co., 293 S.W. 944, 945 (Ky. 1927).

         When this case arose, in late 2009, KRS 139.200 imposed "upon all retailers" a tax-the general sales tax-"at the rate of six percent (6%) of the gross receipts derived from" retail sales of tangible personal property and digital property, and from the furnishing of certain services. KRS 139.310 imposed "an excise tax"-the use tax (step one from above)-on "the storage, use, or other consumption in this state of tangible personal property and digital property purchased for storage, use, or other consumption in this state at the rate of six percent (6%) of the sales price of the property." "Every person storing, using or otherwise consuming in this state tangible personal property or digital property purchased from a retailer is liable for the use tax levied under KRS 139.310." KRS 139.330. KRS 139.500 and KRS 139.510 then (step two) exempted from the use tax any property which had been subjected to sales tax, either in Kentucky[7] or in another state (to the extent of that tax, up to the six percent Kentucky rate), provided that the other state grants a similar credit for sales taxes paid in Kentucky.[8]

         Generalized sales taxes, such as this, with their complementary use taxes, first became widespread in the 1930s, a depression-era response to reduced state revenues. Pomp, supra, at 1125. Kentucky appears briefly to have joined that trend, with the enactment of a general sales tax in 1934, but that tax was repealed at the General Assembly's next session, in 1936, and the state reverted to the former practice of imposing sales and use taxes only on a few specified articles. Our current general sales and use tax regime was not enacted until 1960. See George v. Scent, 346 S.W.2d 784, 787 (Ky. 1961) (noting this development). With that understanding of the tax at issue, our focus turns to the Kentucky Constitution and the section on which IGS/Tri-State premise an exemption claim.

         B. Section 170 of the Kentucky Constitution

         Section 170 emanated from the 1890 Constitution Convention and had no counterpart in the three earlier Kentucky Constitutions. The section has been amended six times since its adoption in 1891, all revisions occurring after 1955 and none having any relevance to the portion of § 170 on which IGS/Tri- State relies. The section now provides in substantial part as follows, with original language since omitted in brackets and revisions from 1955 forward reflected by underlining:

There shall be exempt from taxation public property used for public purposes; [places actually used for religious worship, with the grounds attached thereto and used and appurtenant to the house of worship, not exceeding one-half acre in cities or towns, and not exceeding two acres in the country;] places of burial not held for private or corporate profit; real property owned and occupied by, and personal property both tangible and intangible owned by, institutions of religion; institutions of purely public charity, and institutions of education not used or employed for gain by any person or corporation, and the income of which is devoted solely to the cause of education, public libraries, their endowments, and the income of such property as is used exclusively for their maintenance; [all parsonages or residences owned by any religious society, and occupied as a home, and for no other purpose, by the minister of any religion, with not exceeding one-half acre of ground in towns and cities and two acres of ground in the country appurtenant thereto;] household goods [and other personal property] of a person [with a family, not exceeding two hundred and fifty dollars in value;] used in his home; crops grown in the year in which the assessment is made, and in the hands of the producer; [and all laws exempting or commuting property from taxation other than the property above mentioned shall be void.] and real property maintained as the permanent residence of the owner, who is sixty-five years of age or older, or is classified as totally disabled under a program authorized or administered by an agency of the United States government or by any retirement system either within or without the Commonwealth of Kentucky .... The real property may be held by legal or equitable title, by the entireties, jointly, in common, as a condominium, or indirectly by the stock ownership or membership representing the owner's or member's proprietary interest in a corporation owning a fee or a leasehold initially in excess of ninety-eight years. The exemptions shall apply only to the value of the real property assessable to the owner or, in case of ownership through stock or membership in a corporation, the value of the proportion which his interest in the corporation bears to the assessed value of the property. The General Assembly may authorize any incorporated city or town to exempt manufacturing establishments from municipal taxation, for a period not exceeding five years, as an inducement to their location. Notwithstanding the provisions of Sections 3, 172, and 174 of this Constitution to the contrary, provide by law an exemption for all or any portion of the property tax for any class of personal property.

         The section, on its face, is replete with references to property, both real and personal, including residences, places of burial and crops. Section 170 precedes § 171 authorizing the state property tax with provisions regarding classification and uniformity; § 172 requiring property to be assessed at fair cash value; § 173 providing that misuse of public funds is a felony; § 174 requiring property to be taxed at its value regardless if owned by an individual or corporation; and § 175 prohibiting the Commonwealth from surrendering or suspending the power to tax property.

         Through the years, this Court and its predecessor have recognized that § 170 and other sections in that "run" of constitutional provisions address only property (ad valorem) taxes. Referring to the timeframe of the 1890 constitutional debates, this Court in Gillis v. Yount, 748 S.W.2d 357, 358 (Ky. 1988), with Justice Leibson writing for the majority, noted: "The primary source of tax revenue at the time was property taxes, and this is where the problems with unfairness were perceived, so these constitutional limitations, covered principally in Kentucky Constitution Sections 170-175, deal only with the power to tax property, or ad valorem taxes." (emphasis in original). This conclusion was by no means unprecedented. See, e.g., City of Louisville v. Cromwell, 233 Ky. 828, 27 S.W.2d 377, 378 (1930) ("Independently of any prior interpretation of section 170 of our constitution, its language and that of its sections 171, 172, and 174 would appear to exclusively deal with only ad valorem taxes . . . ."); Reynolds Metal Co. v. Martin, 269 Ky. 378, 107 S.W.2d 251, 259 (Ky. 1937) ("[A]n income tax is not a property tax, and so it is not subject to the uniformity provisions of sections 171 and 172 of the Constitution, nor is it governed by the provision as to exemptions in section 170").

         C. The Corbin YMCA Opinion

         A century ago, in Corbin Young Men's Christian Ass'n v. Commonwealth, 181 Ky. 384, 205 S.W. 388, 389 (1918) ("Corbin YMCA"), confronted with a YMCA "convicted" of operating a restaurant without a license and fined $60, the Court veered from that view to conclude that "institutions of public charity" were entitled to an exemption from not only their property taxes "but also necessarily [taxes on] all of their legitimate activities that are consistent with and in furtherance of the purposes for which they were organized." The Court based that conclusion on its parsing of Ky. Const. § 170 and two prior decisions, Trustees of Ky. Female Orphan School v. City of Louisville, 100 Ky. 470, 36 S.W. 921(1896) and Commonwealth v. Young Men's Christian Ass'n, 116 Ky. 711, 76 S.W. 522 (1903). Significantly, both of those prior decisions involved property taxes and focused on the scope of the § 170 property exemption.

         In Trustees of Ky. Female Orphans School, the Court held that rental property in Louisville owned and operated by an orphanage located in Midway was exempt from state, county and municipal ...

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