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Sixth Circuit Court Of Appeals Upholds Constitutionality Of Kentucky Multi-Channel Video Programming Tax Structure

06.14.2007

In DirecTV, Inc. v. Treesh, Case No. 06-5523 (6th Cir., May 31, 2007), the United States District Court of Appeals for the Sixth Circuit held that Kentucky’s newly enacted tax on multi-channel video programming did not discriminate against interstate commerce in violation of the Commerce Clause of the United States Constitution.

DirecTV, Inc. and EchoStar Satellite, LLC (collectively, “Satellite Companies”), both headquartered outside of Kentucky, provide multi-channel video programming to subscribers via satellites stationed above the earth. The Federal Government grants Satellite Companies the right to transmit programming signals from satellites located in orbit which are received by a subscriber by means of a small satellite dish mounted on or near their house.

Cable television operators (“Cable Companies”) also provide multi-channel video programming; however, they do so by means of cable networks located in Kentucky. Cable Companies receive programming in Kentucky and transmit such to Kentucky subscribers by way of cables laid in the Commonwealth and connected to their subscribers’ television sets in set top boxes. The three largest Cable Companies in Kentucky are headquartered in states other than Kentucky. Cable Companies must obtain permission from local governments in order to lay or string cable which is granted by means of franchise agreements and permits and typically pay a franchise fee of 5% of gross revenue to the applicable local government.

Satellite Companies compete with Cable Companies in the market for multi-channel video programming distribution as both sell various packages of television channels including local television stations and cable programming. Prior to the 2005 legislation, which was the subject of Satellite Companies’ Complaint, Cable Companies were typically subject to a local franchise fee of 5% of gross revenue. The 2005 legislation, 2005 Ky. H.B. 272 – a part of what is commonly known as Kentucky Tax Modernization – created two new taxes on multi-channel video programming services: [1] a new excise tax of 3% on multi-channel video programming services, which the provider must collect from the purchaser; and [2] a new gross revenue tax of 2.4% on a multi-channel video programming service provider’s gross revenues which may not be collected from a purchaser.

The 2005 legislation also created a fund into which all revenues from the gross revenue and excise tax must be deposited. The money in the fund is allocated among the Commonwealth and its political subdivisions, school districts and special districts. A portion of the fund is distributed to local governments according to a local historical percentage.

Importantly, KRS 136.660 prohibits a local government from levying a franchise fee or tax on a multi-channel video programming service, whether charged to a provider or purchaser. If such a franchise fee or tax is levied, the statute prohibits the local government from sharing in the proceeds of the excise and gross receipts taxes and provides a credit in the amount of the franchise fee or tax imposed against the local franchise tax or fee imposed against the state-levied excise and gross receipts taxes.

The Satellite Companies contended that the 2005 legislation, which affords Cable Companies credits against the state excise and gross revenue taxes and relief from franchise fees, was discriminatory of interstate commerce in violation of the Dormant Commerce Clause. The Court characterized the Satellite Companies’ argument as follows: the Cable Companies receive relief from a portion of their operating costs (i.e., the local franchise fees or taxes) in return for paying the new taxes; conversely, Satellite Companies pay new taxes but receive no relief from their operating costs. As such, Satellite Companies argue that this constitutes discrimination because Satellite Companies which employ out-of-state facilities to distribute television service are burdened, and Cable Companies which employ in-state facilities to distribute television service are benefited by the 2005 legislation.

The Court briefly reviewed the Satellite Companies’ challenges to the District Court’s findings of fact. Although the Court of Appeals identified errors on the part of the District Court, it nonetheless determined that the District Court had a reasonable basis for the dismissal of the Complaint. . The Court then turned to a review of the Dormant Commerce Clause, which prohibits discrimination against interstate commerce and may be implicated where in-state economic interests are favored over out-of-state competitors.

Initially, the Court indicated that, had Kentucky imposed an equal state tax on both the Satellite Companies and Cable Companies, without providing the credit for the franchise fee or banning those fees altogether, the new taxes would not be violative of the Commerce Clause. Further, the Court determined that had Kentucky solely banned local governments from imposing the franchise fees on Cable Companies, that too, would not have done violence to the Commerce Clause. The Court noted that state and local governments are not required to charge for the use of local rights-of-way. Likewise, the provision of access to a state infrastructure, without charge, is an option freely exercisable by the state.

The Satellite Companies’ argued that Kentucky’s new tax structure is similar to one found to violate the Dormant Commerce Clause in West Lynn Creamery v. Healy, 512 U.S. 186 (1994). In West Lynn Creamery, Massachusetts required milk dealers in the state to contribute to a price equalization fund, regardless of where they bought their products, and then distributed the proceeds of the fund solely to in-state dairy producers. The U.S. Supreme Court found that such a structure violated the Commerce Clause.

The Court distinguished the current case from West Lynn Creamery in several important respects. First, in the instant case, the challenged subsidy is not a direct monetary subsidy, but only a beneficial right to conduct business and use local rights-of-way without local taxation and fees. Second, in West Lynn Creamery, the purpose and effect of the tax and subsidy was to divert market share from out-of-state goods to an in-state competitive group. However, in the case of multi-channel programming the goods are distinct with two very different means of delivery and broadcast. Lastly, the Court determined that the purpose of the 2005 amendments included non-market share related goals, such as simplification of the tax fees related to Cable Companies and also how to best collect taxes from the Satellite Companies.

The Court found that the Satellite Companies’ allegations were insufficient to demonstrate the 2005 amendments created the functional equivalent of a protective tariff. The State, in enacting the amendment, merely sought to simplify the tax structure and provide a more uniform state taxation scheme. Thus, the Court of Appeals affirmed the District Court’s grant of the Defendant’s Motion to Dismiss.

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