Truk Continental Hotel, Inc v Chuuk [1995] FMSC 19; 7 FSM Intrm. 117 (App. 1995) (17 April 1995)

FEDERATED STATES OF MICRONESIA
SUPREME COURT APPELLATE DIVISION
Cite as Truk Continental Hotel, Inc v Chuuk, [1995] FMSC 19; 7 FSM Intrm. 117 (App. 1995)

TRUK CONTINENTAL HOTEL, INC., a corporation, and RAYMOND SETIK,
Appellants,

vs.

STATE OF CHUUK,
Appellee.

APPEAL CASE NO. C3-1994

OPINION

Argued: January 19, 1995
Decided: April 17, 1995

BEFORE:

Hon. Martin G. Yinug, Associate Justice, FSM Supreme Court
Hon. Lyndon L. Cornelius, Temporary Justice, FSM Supreme Court*
Hon. Alfred T. Goodwin, Temporary Justice, FSM Supreme Court**

*Chief Justice, Kosrae State Court, Lelu, Kosrae
**Senior Judge, United States Ninth Circuit Court of Appeals

APPEARANCES:

For the Plaintiff:
R. Barrie Michelsen, Esq.
Law Offices of R. Barrie Michelsen
P.O. Box 1450
Kolonia, Pohnpei FM 96941

For the Defendant:
Wesley Simina, Esq.
Attorney General
Office of the Chuuk Attorney General
P.O. Box 189
Weno, Chuuk FM 96942

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HEADNOTES

Federalism - National/State Power; Taxation - Constitutionality
Only the national government may constitutionally tax income. The states' taxing power does not include the power to tax income. Truk Continental Hotel, Inc. v. Chuuk, [1995] FMSC 19; 7 FSM Intrm. 117, 119 (App. 1995).

Taxation
Rents are income taxable under the FSM Income Tax Statute, and a state tax on gross rental receipts combines to create vertical multiple taxation of a form of income. Truk Continental Hotel, Inc. v. Chuuk, [1995] FMSC 19; 7 FSM Intrm. 117, 119 (App. 1995).

Taxation
The name given a tax by a taxing authority is not necessarily controlling as to the type of tax it is. Truk Continental Hotel, Inc. v. Chuuk, [1995] FMSC 19; 7 FSM Intrm. 117, 119 (App. 1995).

Taxation
The interval in which a tax is reported and collected and whether it is imposed without regard to profit or loss does not alter whether it is an income tax. Truk Continental Hotel, Inc. v. Chuuk, [1995] FMSC 19; 7 FSM Intrm. 117, 119 (App. 1995).

Federalism - National/State Power; Taxation - Constitutionality
If a state wishes to obtain funding from a consumption tax, it can avoid a constitutional confrontation by making the taxable incident the sale or rental transaction, and by expressing the requirement that the tax be paid by the consumer. Therefore a state tax on the gross rental receipts of a landlord is an unconstitutional tax on income. Truk Continental Hotel, Inc. v. Chuuk, [1995] FMSC 19; 7 FSM Intrm. 117, 120 (App. 1995).

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COURT'S OPINION

PER CURIAM:

Section 4(2) of Chuuk State Law 191-04 levies a tax of ten percent on rents.[1] Article IX, section 2(e) of the Constitution of the Federated States of Micronesia vests in the national government the exclusive power to tax income. We are asked to determine whether the Chuuk rental tax is an unconstitutional tax on income.

This very question was raised before this Court in Sigrah v. Kosrae, [1993] FMSC 34; 6 FSM Intrm. 168 (App. 1993), a challenge to the Kosrae five percent "Transaction Tax" on rents. In Sigrah we acknowledged that the Kosrae "Transaction Tax" and the FSM's national gross income tax both taxed the same revenue, but reasoned that the Kosrae "Transaction Tax" more closely resembled a sales tax than an income tax, and therefore was not an unconstitutional tax on income.

Before the trial division, the plaintiffs conceded that Sigrah was not distinguishable from this case, and that under Sigrah their cause was lost. On January 12, 1994, the Court entered summary judgment against the plaintiffs, stating that "the decision in Sigrah is controlling." The plaintiffs have appealed to this Court, asking that Sigrah be overruled. The State of Chuuk has relied on the Sigrah decision as its brief.

A. General Considerations

Under the FSM Constitution, only the national government may tax income. The taxing power of the states excludes the power to tax income. The FSM national income tax is a 3% tax on gross revenues. One-half of the income tax collected by the national government is returned to the state where the tax was collected. The Congress of FSM can, of course, raise or lower this tax at any time.

Rents are taxable income under the FSM Income Tax Statute. 54 F.S.M.C. 112(5). Under the challenged Chuuk tax, 10% of gross rentals receipts are paid by the lessor directly to the state. Plainly, under the dictionary definition of "income," the Chuuk tax on gross rental receipts would appear to be a gross income tax.[2] Working in tandem, the national and state taxes thus combine to create "vertical multiple taxation of a form of income."

The appellee argues with some conviction that the Chuuk rental tax is a "sales tax" - a tax on the "sale" of rental space. The courts of the FSM have struggled with the distinction between sales and income taxes. Obviously, the name given a tax by a taxing authority is not necessarily controlling. The State Legislature could as well call the rental tax a "doing business tax" - a tax on doing business as a landlord. The amount of the tax would be measured by the amount of business done by the landlord.

B. Reporting Interval

The state argues that a tax levied on a year's total receipts would be an "income tax" but that a sales or rental tax reported and collected intermittently is a consumption, or transaction tax and not an income tax. However, by the same argument, Chuuk could intermittently tax other discrete transactions, such as a secretary's weekly exchange of her labor for wages.

C. Effect of Profit or Loss

The state also argues that because the tax is imposed on each transaction, without regard to the overall profit or loss of the landlord or rental-property owner on an annual basis, the tax is not an income tax but a sales tax. The argument loses force, however, when the state concedes that all of the FSM income tax is a tax on gross income, without regard to the overall success or failure of the enterprise producing the income. Moreover, the state does not explain how we can distinguish what was said in Ponape Fed. of Coop. Ass'n v. FSM, [1985] FMSC 21; 2 FSM Intrm. 124 (Pon. 1985).

There the court noted first that gross revenue has the same meaning as gross income.

It follows that the various forms of revenue subject to tax are also income. The term "gross revenue" is defined in the FSM Income Tax Law as including, among other things "gross receipts . . . derived trade, business, ess, commerce, or sales and . . . interest, ren royalties, ies, fees, or other emoluments." 54 F.S.M.C. 112(5).

Id.

D. Constitutiitutional onal Intent

The intention of the Constitutional draftsmen was clear. The Report by the Committee on Public Finance and Taxation states: "Although vertical multiple taxation is not always undesirable, if it were to be practiced in Micronesia without concern for its total effect on the private and public sectors, there could be no adherence to a consistent fiscal policy for Micronesia." The Constitution carved out income taxation as the province of the federal government, leaving to the states the power to impose sales taxes, or such other consumption taxes as the Chuuk tax on hotel rooms, which is not being challenged in this litigation.

One difference between a sales tax and an income tax has been said to be that a sales tax, paid by the consumer, is a tax on consumption, while a gross revenue tax paid by the seller, renter, or supplier is a tax on potential consumption, in other words, on that person's income. See, e.g., Robert M. Haig, The Concept of Income - Economic and Legal Aspects, in Readings in the Economics of Taxation 54 (Musgrave & Shoup, eds. 1959); Henry C. Simons, Personal Income Taxation 50 (1938). Whether the tax is passed on to the consumer or absorbed by the supplier of the property, the activity that is taxed is the consumption of the good sold or rented.

In a previous case discussing the use of the word "income," the Court gave the word its usual and normal meaning. In Afituk v. FSM, [1986] FMSC 17; 2 FSM Intrm. 260 (Truk 1986), the court defined income by turning to a general dictionary: Webster's Third New International Dictionary (1971). There, the definition of "income" includes:

4a). a gain or recurrent benefit that is usually measured in money and for a given period of time, derives from capital, labor, or a combination of both includes gains from the transaction in capital assets, but includes unrealized advances in value; commercial revenue or receipts of any kind except receipt or returns of capital - see earning income, gross income, net income unearned income, compare profit, wage.

(emphasis added).

It is not the function of the judiciary to instruct the legislative branch, and that is not our purpose in noting that if a state wishes to obtain funding from a consumption tax, it could avoid a constitutional confrontation by making the taxable incident the sale or rental transaction, and by expressing the requirement that the tax be paid by the consumer.

The challenged tax in this case is a clear example of a state government reaching into the same tax base (revenue source) as the federal government has already reserved for its own taxation purposes. While the constitution does not expressly forbid "vertical multiple taxation," the report of the drafting committee reveals that double taxation of the same revenue source was to be avoided because, if unchecked, it could undermine a consistent fiscal policy for Micronesia. One need only contemplate the result if two additional states decided to levy a ten, fifteen, twenty or other percentage tax on the gross receipts of those persons who rent or lease property to consumers. A consistent fiscal policy for Micronesia would be gravely endangered.

In conclusion, we must confess that the constitutional question which we decided in Sigrah v. Kosrae, supra, two years ago, has been reexamined in light of the experience of the tax in the State of Kosrae and in light of the report of the drafting committee of the Constitutional provisions on taxation, and we believe it is better in this young republic to correct our mistakes honestly and as promptly as possible, so that the consistency of our revenue laws can be maintained. As Baron Bramwell put it: "The matter does not appear to me now as it appears to have appeared to me then." Andrews v. Styrap, 26 L.T.R. (N.S.) 704, 706 (Ex. 1872). Accordingly Sigrah v. Kosrae, supra, is overruled, the judgment of the trial division is reversed, and the cause is remanded to the trial court for the entry of judgment for the plaintiff.

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^[1] "A tax of ten percent is hereby levied on a lessor or landlord upon the renting or leasing of his land, building or housing unit, for residential, or office space, or other use, which leasehold is for a period of one month or longer. A leasehold for less than a month shall be taxed on a pro rated basis on the leasehold value." Chk. S.L. No. 191-04, § 4(2).

up>[2] BLACK'S LAW DICTIONARY 687 (5th ed. 1979): "Income: the return in money from one's business, labor, or capital invested; gains, profits, sales, wages, etc."