9 FSM Intrm.380-389

For tax purposes, Telecom is deemed to be part of the national government and is exempt from any and all state tax liability because it functions are so closely intertwined with the national government that it is appropriate to view it as a national government agency for the purpose of taxation and because, although the FSM Constitution does not specifically delegate the power to establish a telecommunications network to the national government, the circumstances presently existing in the FSM support a conclusion that such a power is of an indisputably national character beyond the control of any state. FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 380, 384 (Pon. 2000).

commerce and because the existence, availability and quality of telecommunication services in the FSM clearly impacts on interstate commerce, the FSM government is constitutionally authorized to establish the FSM Telecommunications Corporation and may similarly exempt it from taxes or assessments. FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 380, 384 (Pon. 2000).

Because a Congressional statute set up Telecom to serve the public interest and foster economic development, because Telecom may seek appropriations from Congress and, to the extent approved by the President, grants from sources outside of the FSM, because Telecom's board of directors must submit an annual report reflecting its activities, including financial statements, to the government, and because Telecom has no independent shareholders and is fully owned by the national government, Telecom is deemed, for taxation purposes, to be a part of the national government, and its efforts to carry out its mission should not be hindered by any state's efforts to tax its business activities. FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 380, 385 (Pon. 2000).

A state "use tax" that instead of collecting the tax at the port in order to release the goods, requires the taxpayer to fill out a form prior to release of the goods after which collection of the assessment is deferred for sixty days, is, despite its name, a tax on imports and an unauthorized action to usurp the national government's exclusive power to impose taxes, duties, and tariffs based on imports. FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 380, 386 (Pon. 2000).

A state "use tax" calculated on the value of items brought into the state plus the cost of shipping, handling, insurance, labor or service cost, transportation charges or any expenses whatsoever, has nothing to do with benefits provided by the state associated with the use of the item and cannot be justified as having a substantial nexus with the state. It only serves as an unauthorized burden on interstate commerce. FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 380, 386 (Pon. 2000).

By making the taxing powers allocated between the national and state governments of Micronesia exclusive and distinct and allocating the exclusive power to tax income and imports, the Constitution's framers sought to avoid vertical multiple taxation and ensure a consistent fiscal policy for Micronesia. FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 380, 387-89 (Pon. 2000).

This memorandum follows an order issued on December 30, 1999, in which the Court granted summary judgment in favor of FSM Telecommunications Corporation (Telecom) and declared Pohnpei's "use tax" unconstitutional. 1 [FSM Telecomm. Corp. v. Department of Treasury, 9 FSM Intrm. 292

This memorandum is explanatory in nature. It does not alter or amend the terms of the order previously issued, the judgment entered in Telecom's favor or the injunction against Pohnpei concerning imposition and collection of use taxes. Relevant portions of the order are set forth at the end of this memorandum for reference Purposes.

This matter comes before the Court on cross motions for summary judgment, the first filed by Telecom on January 21, 1998, and the second by the Department of Treasury and Administration of the State of Pohnpei (Pohnpei) on February 2, 1998. The motions center on Pohnpei's imposition of a "use tax" on Telecom for its importation of a motor vehicle and telephone equipment purchased outside the FSM. The parties submitted their motions on stipulated facts and agree that this case does not involve any dispute over issues of material fact. They agree, as does the Court, that the motions turn strictly on questions of law thereby making summary judgment an appropriate procedure for resolving this case.

Telecom's principal argument is that it should be deemed exempt from the tax under state and national law as an entity wholly owned and operated by the national government functioning solely for public benefit. Telecom asserts that because of its unique role and special characteristics it should be declared part of the national government for tax purposes and therefore exempt from state taxation. The exemption is claimed under 21 F.S.M.C. 208 and Section 14-4(4) of Pohnpei State Law No. 4L-35-97.2 The issues presented by Telecom's motion are framed so as not to call into question the constitutionality of the state taxing scheme.

Pohnpei responds to Telecom's motion by asserting that Telecom's corporate status exposes it to taxation under state law (regardless of stock ownership and a degree of indirect control by the FSM national government) and by claiming that the national government is not authorized by the FSM Constitution to prevent the imposition of a "use tax" on imported goods used or consumed in the State of Pohnpei. Thus, Pohnpei urges the Court to uphold the November 24, 1997 decision of its Department of Treasury and Administration finding that the use tax properly applies to Telecom under these circumstances.

In an effort to resolve issues raised in its answer by way of affirmative defense, Pohnpei counters Telecom's motion with one of its own requesting a declaration that the use tax scheme at issue is not violative of the FSM Constitution, Article VIII, Section 3, prohibiting state and local governments from imposing taxes which restrict interstate commerce, or Article IX, Section 2(d), expressly delegating to Congress the power to impose taxes based on imports. Pohnpei makes its motion aware that the resolution of Telecom's motion does not require the Court to address the question of whether the use tax law is in conflict with the FSM Constitution even though Telecom's complaint includes a second cause of action raising that very argument. Pohnpei justifies its request for an order declaring that the use tax is not in conflict with the FSM Constitution out of concern over challenges to the imposition of the use tax on constitutional grounds. To avoid protracted future litigation on this issue, Pohnpei brings its motion on Telecom's second cause of action for declaratory relief.

On or about April 21, 1997, Telecom purchased telephone equipment in Hawaii and imported it into the State of Pohnpei. The purchase price of the equipment was $17,138.00 and shipping charges were $2,014.92. After subtracting a $500.00 yearly deductible, a 1% general merchandise use tax was applied and $186.53 in tax liability was assessed on Telecom by Pohnpei. On or about June 2, 1997, Telecom purchased a Toyota pick-up truck in Guam and imported it into the FSM with the point of entry being Kolonia, Pohnpei. Telecom paid $12,335.00 for the vehicle and $1,145.00 in air freight charges. The State of Pohnpei required Telecom to fill out a use tax return in order to take possession of the vehicle. After applying a 7% motor vehicle use tax to the $13,480.00 combined value of the vehicle plus freight charges, Pohnpei levied a $943.60 tax on Telecom.

On or about September 16, 1997, Telecom received correspondence from the Department of Treasury and Administration demanding payment of $1,378.76 which included the above referenced taxes plus $226.03 in penalties and $22.60 in interest. Telecom protested the imposition of these charges under the procedures set forth in Section 10-1 of the Pohnpei Comprehensive Taxation Reform Act of 1997, Pon. S.L. No. 4L-35-97 (Tax Act).

In accordance with applicable provisions of the Tax Act, an administrative hearing before the Director of the Department of Treasury and Administration (Director) was held on November 5, 1997. On November 24, 1997, the Director issued her ruling rejecting Telecom's claims of exemption and its challenges to the constitutionality of the taxing scheme. Telecom perfected its right to appeal the decision by paying $1,378.76 under protest and on December 23, 1997 filed the instant lawsuit.

Telecom's complaint states two causes of action. The first is an appeal of the Director's decision denying Telecom's claim of exemption from the tax under 21 F.S.M.C. 208 and Pohnpei State Law No. 4L-35-97, Section 14-4(4), and rejecting Telecom's argument that the taxing scheme is violative of the FSM Constitution which prohibits states from restricting or regulating interstate

commerce and from taxing imports. The second cause of action is for declaratory and injunctive relief seeking a determination that Telecom is exempt from the state use tax on the same grounds raised in the first cause of action and that the "use tax" is unconstitutional as a tax restricting interstate commerce and as an impermissible tax on imports.

The Court agrees with Telecom on the issue raised by its motion. For tax purposes, the Court holds that Telecom should be deemed part of the national government and is exempt from any and all tax liability to the State of Pohnpei. This conclusion is based on two primary considerations. First, Telecom exists because of the Federated States of Micronesia Telecommunications Act of 1981, 21 F.S.M.C. 201 et seq. (Telecommunications Act). By creating a telecommunications corporation, the FSM government laid the foundation for the establishment of a comprehensive telecommunications network for public benefit. The national government recognized the importance of widely available, reliable communication services as a means of promoting economic development and improving the health, education and welfare of FSM citizens. Telecom's existence, its purpose and the manner in which it functions are so closely intertwined with the national government the Court believes it is appropriate to view it as an agency of the national government for the purpose of taxation.

Second, although the FSM Constitution does not specifically delegate the power to establish a telecommunications network to the national government, the circumstances existing in the FSM at present support a conclusion that such a power is of an indisputably national character beyond the control of any state. Additionally, the FSM Constitution, Article IX, Section 2(g) expressly delegates to Congress the power to regulate interstate commerce. The existence, availability and quality of telecommunication services in the FSM clearly impacts on interstate commerce. Hence, the FSM government was constitutionally authorized to establish the FSM Telecommunications Corporation and may similarly exempt it from taxes or assessments, including those at issue here.

The Court also holds in favor of Telecom on the issues raised by Pohnpei in its motion for summary judgment. The Pohnpei Comprehensive Taxation Reform Act of 1997, S.L. No. 4L-35-97 is in violation of the FSM Constitution insofar as the "use tax" involved here is concerned. The subject tax represents an unconstitutional burden on interstate commerce in violation of FSM Constitution, Article VIII, Section 3. Likewise, the Court finds that the use tax provisions of the Tax Act unconstitutionally intrude upon the national government's exclusive power to impose taxes, duties, and tariffs based on imports, FSM Constitution, Article IX, Section 2, thereby jeopardizing the sound fiscal policy engendered by the FSM Constitution's implicit limitations on vertical multiple taxation of the same tax base.

Court is guided by FSM Development Bank v. Estate of Nanpei, 2 FSM Intrm. 217 (Pon. 1986). There, the Court held that the FSM Development Bank (Bank) should be deemed part of the national government within the meaning of Article XI, Section 6(a) of the Constitution of the Federated States of Micronesia so that cases in which the Bank is a party fall within the FSM Supreme Court's original and exclusive jurisdiction. From an analysis of the legislation establishing the Bank, the FSM Development Bank court determined that it was created for the specific public purpose of helping people meet the needs of the FSM's developing economy. The Court further recognized that the Bank has no private owners; that Congress appropriates funds for the Bank's operations and is authorized by statute to undertake responsibility for certain of its obligations; that the Bank is obligated to submit annual financial reports to the national government; and, that the statute creating the Bank specifies that it "shall exist and operate solely for the benefit of the public and shall be exempt from any taxes and assessments on any part of its property, operations or activities." Id. at 220.

While not a mirror image of the statute establishing the Bank, the Telecommunications Act is substantially similar in many respects, particularly as it pertains to the unique role played by Telecom in serving the public interest and fostering economic development. The Telecommunications Act expressly states that Telecom has the responsibility, "to the extent practicable, to expand telecommunication services to areas and communities in the Federated States of Micronesia that are presently unserved or poorly served and to improve the quality, reliability, and variety of services available to all users in a manner consistent with commercial reasonableness and with promoting economic development, the advancement of education and health care, and the preservation of the cultural identity of the people of the Federated States of Micronesia." 21 F.S.M.C. 203(4) (emphasis added).

Similarly, although Telecom is set up to have fiscal autonomy, the Telecommunications Act authorizes Telecom, "to seek appropriations from the Congress of the Federated States of Micronesia and, to the extent approved by the President of the Federated States of Micronesia, grants from sources outside of the Federated States of Micronesia, of such funds as are necessary to supplement revenues to provide for the operations, maintenance, and expansion of the telecommunications system of the Federated States of Micronesia." 21 F.S.M.C. 226.

Moreover, pursuant to 21 F.S.M.C. 227, Telecom's board of directors must submit an annual report reflecting its activities, including financial statements, to the President of the FSM, FSM Congress, and the Governor and Legislature of each state. According to uncontradicted evidence supporting its motion, Telecom has no independent shareholders and is fully owned by the government of the Federated States of Micronesia. See Affidavit of Mathias Lawrence at 1.

These factors, taken in concert, strongly support a conclusion similar to the one reached in the FSM Development Bank case. For a limited purpose ) taxation in this instance ) Telecom should be deemed part of the national government because of its unique characteristics and the special role it plays in furthering the interests of the people of the FSM. With the advent and proliferation of the Internet, telecommunication services are now far more likely to have a direct and immediate impact on the economic well being of the FSM than in 1981 when Telecom came into being, or at any other time in history. Telecom's efforts to carry out its mission should not be hindered by the efforts of any state to tax its business activities.

Accordingly, the Director's decision to uphold the imposition of the "use tax" assessed on Telecom was reversed on the grounds that it was based on an erroneous conclusion of law. Because Telecom is part of the national government for tax purposes, the exemption from taxation given to the FSM national government under § 14-4 of the Tax Act applies here. Therefore, Telecom's claim of exemption is supported by both state and national law.

The second cause of action in Telecom's complaint and Pohnpei's third affirmative defense serve as the subject of Pohnpei's motion for summary judgment. In its prayer for relief, Pohnpei requests a determination that the Tax Act is constitutional. On the other hand, Telecom asserts that in spite of the "use tax" moniker, the tax is actually a tax on imports and that it interferes with interstate commerce.

The FSM Constitution, Article IX, Section 2, expressly delegates to Congress the power "to impose taxes, duties, and tariffs based on imports." The issue of a state tax impermissibly infringing upon the national government's exclusive power to tax imports was addressed by the appellate division of this Court in Innocenti v. Wainit, 2 FSM Intrm. 173 (App. 1986). In Innocenti, the Court struck down a Chuuk State excise tax as an unconstitutional tax on imports. The Court stated the following in regard to the excise tax:

Taxes imposed on goods because of their "entry...into a port of entry for the State of Truk," which taxes are "levied...at the port of entry" in amounts based upon the quality or value of imported goods and which must be "paid to the Division of Revenue prior to the release of the items from the port of entry" are taxes based on imports.

Telecom urges that the only slight deviation in the Pohnpei "use tax" law is that instead of collecting the tax at the port in order to release the goods, Pohnpei requires the taxpayer to fill out a form prior to release of the goods after which collection of the assessment is deferred for sixty days. Telecom also notes that the Tax Act authorizes the terminal operator to hold merchandise subject to the tax at any point of entry into the state until the purchaser has filled out the appropriate tax form thereby obligating him to pay the tax. Pon. S.L. No. 4L-35-97, § 14-1(6).

The Court agrees that the "use tax" at issue here is substantially similar to the "excise tax" struck down in Innocenti. The sixty day grace period does not alter the effect of the tax. Despite its name, the Pohnpei "use tax" is a tax on imports. Whether intended or not, it is an unauthorized action by Pohnpei State to usurp the national government's exclusive power to impose taxes, duties, and tariffs based on imports.

The Court also notes that the "use tax" is calculated on the value of items brought into the state plus the cost of shipping, handling, insurance, labor or service cost, transportation charges or "any expenses whatsoever." See Pon. S.L. No. 4L-35-97, § 14-1(1). Yet, these costs are strictly import related. They have nothing to do with benefits provided by the State associated with the use of the item. Consequently, this aspect of the taxing scheme cannot be justified as having a substantial nexus with the State of Pohnpei. To the contrary, it seems only to serve as an unauthorized burden on interstate commerce.

Article VIII, Section 3 of the FSM Constitution specifically states that, "[s]tate and local governments are prohibited from imposing taxes which restrict interstate commerce." In keeping with this proposition, Article IX, Section 2 of the FSM Constitution expressly delegates to Congress the power to regulate interstate commerce. Prohibiting the states from imposing taxes on imports and giving Congress the power to regulate interstate commerce serves to promote a consistent fiscal policy for the FSM. The Court finds it hard to imagine a tax assessed by a state with the potential of interfering with interstate commerce more significantly than the one at issue here.

Moreover, the subject "use tax" imposes two taxes on the same tax base, a practice sometimes referred to as "vertical multiple taxation." In Truk Continental Hotel, Inc. v. Chuuk, 7 FSM Intrm. 117 (App. 1995), the appellate division of this Court confronted the issue of vertical multiple taxation in the context of a Chuuk state tax on rents challenged as violative of the Constitution's prohibition on states from charging an income tax. To determine the constitutional intent of delegating certain taxing power to the national government, the Truk Continental court examined the Report by the Committee on Public Finance and Taxation, SCREP No. 38, where the Constitution's framers addressed the mechanism by which the states receive revenue generated by income and import taxes. Pertinent portions of that report also apply to the case at bench. They are the following:

"In order to avoid the conflicts and tangles of overlapping tax jurisdiction, the duplication of collection agencies, and clashes of fiscal policy, the concurrent right of taxation has been widely avoided, and tax sources have nearly always been assigned exclusively to one level of government or the other."

Your Committee also adopted the proposition that the state government should be guaranteed a high degree of fiscal autonomy. In the Proposal, this guarantee has taken the form of a "not less than 50%" return of all central income and import tax revenues back to the state in which such revenues were collected. This intergovernmental financial transfer shall be wholly unconditional--with no discretion to increase the proportional return above the 50% figure. All other taxing powers are reserved expressly to the states.

"SECTION . The National Legislature shall have the exclusive power to impose and provide for the collection of (1) taxes, duties and tariffs based on imports, and (2) taxes based on income, both personal and business; PROVIDED HOWEVER, that all such taxes shall be applied uniformly throughout the nation and not less than 50% of the revenues collected pursuant to this section shall be paid into the government treasury of the state wherein such revenues were collected."

As noted earlier in this report, your committee believes that the taxing powers allocated between the national and state governments of Micronesia should be exclusive and distinct. While the functions performed by different levels of government ought to be shared, the logic in such a system does not apply to the taxing power in a Micronesian federation. The reasons why your Committee arrived at this conclusion should be clear:

Also referred to as tax overlapping, multiple taxation is a situation in which the same "tax base" is taxed more than once. "Vertical multiple taxation" refers to overlapping taxation by two levels of government. 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

A further reason for assigning separate taxing powers to separate levels of government involves the intent to avoid future legal disputes between national and state governments over the "reach" of their respective taxing authorities. To the greatest extent possible, a constitution must anticipate and avoid disputes, not create them. This includes attempting to reduce intergovernmental fiscal conflicts.

The Court finds it significant that the framers of the Constitution sought to ensure the uniform application of taxes as a means of fostering a consistent fiscal policy in Micronesia. Commenting on the potential pitfalls of a non-uniform approach to taxing income, the Truk Continental court said the following:

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.

The wisdom of these words ring true in this case as well. The FSM Constitution, Article IX, Section 5, mandates that national laws be imposed uniformly and provides that not less than 50% of the revenues collected from income and import taxes shall be paid into the treasury of the state where collected. The FSM imposes a 4% import tax on general merchandise including motor vehicles. 54 F.S.M.C. 201. Half of the revenues generated from national taxes assessed on imports into the State of Pohnpei already go to the State. This provides revenue equal to two percent of the value of every non-exempt item entering Pohnpei. Pohnpei's assessment of a one percent "use tax" on Telecom for the telephone equipment and a seven percent tax for the motor vehicle circumvents the Constitution's express allocation of taxing power and distribution.

Recent changes in the Tax Act provide further evidence that the tax involved here is in conflict with the Constitution's framer's desire to maintain national taxing uniformity by avoiding overlapping taxation of the same revenue source. This Court takes judicial notice of Pohnpei State Law No. 4L-113-99 amending Section 11-2 the Tax Act to increase the "use tax" on general merchandise from one percent to five percent.4 The telephone equipment imported by Telecom on or about April 21, 1997

was subject to a one percent use tax. Under the amended version of the Tax Act ) signed into law on January 4, 1999 with an effective date of March 1, 1999 ) Telecom would be assessed a five percent tax in the future on similar imported equipment. The same holds true for other taxpayers subject to the tax. Thus, the cost of doing business in the State of Pohnpei has been adversely effected by the change. The Court can imagine a scenario where a business operating in multiple FSM states with plans to expand or upgrade its operations will be forced to forgo or delay work in Pohnpei due to the increased costs of doing business here. This will most certainly have an adverse effect on interstate commerce in a manner the framers sought to avoid by requiring import taxes to be applied uniformly.

As stated in its order of December 30, 19995, the Court reiterates that for tax purposes Telecom shall be deemed part of the national government thereby making it exempt from the tax at issue under 21 F.S.M.C. 208 and Pohnpei State Law No. 4L-35-97, and that the "use tax" is a tax on imports which impermissibly interferes with interstate commerce such that the use tax provisions of the Tax Act are in violation of the FSM Constitution, Article IX, Sections 2(d) and (g), and Article VIII, Section 3, respectively.

Unfortunately, FSM Supreme Court Chief Justice Andon L. Amaraich experienced a medical emergency in early January 2000 requiring treatment in Hawaii. Justice Amaraich departed from the FSM on January 26, 2000 prior to completing this memorandum of decision. He returned to work on May 8, 2000. Hence, the delay in issuing this memorandum.

2. Telecom's motion focuses on the first cause of action in its complaint which is an appeal of an administrative hearing decision by the Director of the Pohnpei Department of Treasury and Administration concluding that Telecom is subject to the use tax.

Accordingly, Telecom's motion for summary judgment is granted and the Director's decision of November 24, 1997 is hereby reversed. The declaratory judgment sought by Pohnpei's motion is hereby entered in favor of Telecom. Consequently, the state of Pohnpei is hereby enjoined from assessing further use taxes under Pohnpei State Law Nos. 4L-35-97 and 4L-92-99 and from accepting or collecting any use taxes assessed but not due and payable under Section 14-7 of the Tax Act as of the date this order is signed.