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In the case Diversified Ingredients, Inc. v. Testa, Diversified Ingredients, a Missouri-based supplier of pet food, feed, and food ingredients, sued Ohio’s Tax Commissioner, Joseph Testa, for the Ohio Department of Taxation’s potential assessment of $561,448 for unpaid tax, penalties, and interest under Ohio's Commercial Activity Tax (CAT). 

Diversified filed its case in the federal district court in Missouri, seeking a declaration that the state of Ohio lacked the necessary jurisdiction to tax the company’s “transactions with customers located outside Ohio[,] for goods that are manufactured and shipped from suppliers outside of Ohio, under contracts negotiated and executed outside Ohio.”

Ohio’s CAT, levied on the privilege of doing business in the state, as measured by a company’s gross receipts from Ohio consumers, is under frequent fire from various entities, as we have discussed. And to the frustration of many, this spring the parties settled the case Crutchfield Corp. v. Testa that challenged the application of the CAT to internet retailers with no physical presence in Ohio, leaving the tax fully upheld.

The Diversified case also leaves things unchanged, at least for now. Earlier this month, the United States Supreme Court denied Diversified’s cert petition.

In the district court

Diversified’s case was based on the theory that it should not be subject to the CAT because its contracts for the sale of pet food ingredients are with customers located outside of Ohio. Although per those contracts, Diversified’s products are shipped into the Buckeye State, the firm’s complaint alleged that it has “no actual relationship” to Ohio.  Thus, it should have no CAT obligation, which the Department of Taxation threatened to assess pursuant to Diversified’s failure to pay it for the previous eight years. 

The district court held that it lacked jurisdiction over the case in the first place, agreeing with the Department that the Tax Injunction Act (TIA) “explicitly bars federal district courts from entertaining jurisdiction over challenges to state systems of taxation.”

As the 8th Circuit explained, the TIA provides that the “district courts shall not enjoin, suspend or restrain the assessment, levy or collection of any tax under State law where a plain, speedy and efficient remedy may be had in the courts of such State... Congress enacted the TIA to ‘transfer jurisdiction to the state courts’ to grant injunctive relief that could interfere with the State's power to assess, levy, and collect taxes.”

The district court recognized that “there exists a plain, adequate, complete, speedy and efficient remedy exists under Ohio state law,” which comports with the TIA’s purpose. Accordingly, challenges to the state’s CAT should be made “initially and exclusively with the Tax Commissioner.”  Only after the commissioner issues his assessment, which had not occurred at the time of the district court’s decision, does a taxpayer have recourse, filing a petition for reassessment, which allows for a request for a hearing. 

Thereafter, the taxpayer may then appeal the final determination to the Ohio Board of Tax Appeals, the decision of which may be further appealed to an Ohio court of appeals, or directly to the Ohio Supreme Court, and then to the United States Supreme Court.

Diversified argued that that this procedure threatens its resources and federal immunity, but the court countered that the statutory framework provides “ample opportunity to appeal the tax assessment, as well as the constitutionality of the imposition of that assessment.”

The court also explained that federal courts must abstain from hearing this state tax controversy pursuant to principles of comity and federalism, which “restrain federal courts from entertaining claims for relief that risk disrupting state tax administration.” The Court explained that “…Ohio's courts are better equipped to determine the constitutionality of the CAT.”   Similarly, in 2010 the Ohio Tax Commissioner prevailed in the U.S. Supreme Court case Levin v. Commerce Energy, where the High Court held that federal courts generally must abstain from exercising jurisdiction over state tax cases due to comity and federalism.

For these reasons, the district court dismissed the lawsuit. 

In the 8th Circuit

The federal appellate court concurred with district court’s rationale and outcome.  It underscored the TIA argument, observing that “the Supreme Court has continued to refer to the TIA as limiting subject matter jurisdiction.”  In addition, the 8th Circuit cited the Commerce Energy case in affirming the District Court’s decision to abstain under comity principles.

In its complaint, noted the circuit court, Diversified also lodged allegations relative to the Interstate Income Act (IIA), as a limit on state taxation of net income. The IIA establishes a minimum standard for imposing net income taxes based on solicitation of interstate sales. The district court, which declined jurisdiction based on the TIA because of the nature of the transactions at issue, did not rule on this argument. 

However, the 8th Circuit touched on the IIA question, as follows:

[The IIA] does not divest state courts of jurisdiction to decide whether the IIA bars a particular state tax assessment, levy, or collection….it does not explicitly provide for exclusive federal jurisdiction, and numerous appellate state court decisions have applied the IIA to specific state tax cases….[nor does it] divest state courts of jurisdiction to decide whether the IIA bars a particular state tax assessment, levy, or collection.

The 8th Circuit recognized the remedies available to Diversified set forth in Ohio’s revenue code, which include granting an Ohio appellate court the authority to consider Diversified’s IIA contentions.  And ultimately, because it went along with the district court’s TIA conclusions, it declined to consider the comity argument.

What’s next?

The U.S. Supreme Court’s denial does not mean that the substance of Diversified’s claims will never see the light of day. As noted in the federal opinions, Diversified has ample opportunities for appeal in Ohio’s courts, once the Department levies its assessment
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