Washington Judge Rules In Favor of Financial Institutions – B&O Tax Measure Discriminates Against Out-of-State Banks

Earlier this month, a Washington state trial judge struck down the state’s recently enacted Business & Occupation Tax (“B&O) measure on large out-of-state financial institutions finding that although the tax measure was facially neutral, the purpose and effect of the tax was discriminatory against out-of-state banks.  See Washington Banker’s Ass’n. et ano. v. State of Washington et al., Docket No. 19-2-29262-8 SEA (Wa. Kings County Super. Ct. May 15, 2020).  As background, the Washington Bankers Association and American Bankers Association (collectively “Bankers Associations”) filed a challenge to invalidate state House Bill 2167, which seeks to impose a higher B&O tax on out-of-state financial institutions whose annual net income equals to or exceeds $1 billion (the measure would nearly double the B&O tax on out-of-state financial institutions from 1.5% to 2.7%).  The Bankers Associations sought to invalidate the law, which became effective January 1, 2020, on the grounds that the measure violates: (1) the state’s constitutional requirement to introduce a bill at least 10 days prior to the adjournment of a legislative session; and (2) the U.S. Constitution’s Commerce Clause because it discriminates against out-of-state financial institutions by imposing a higher tax rate on out-of-state financial institutions versus in-state institutions.  On February 13, 2020, the trial court dismissed the Bankers Associations’ state constitutional challenge, finding that the court was prohibited from looking into legislative procedures preceding the enactment of a statute that is “properly signed and appears fair on its face.”  However, the judge’s decision preserved the Bankers Associations’ federal constitutional cause of action i.e., the B&O tax measure violates the Commerce Clause because it discriminates against out-of-state financial institutions by creating a differential tax rate for in-state versus out-of-state financial institutions.  Upon further briefing, both parties moved for summary judgement and oral argument was held in the matter.

On May 15, 2020, the Hon. Marshall Ferguson issued a formal decision granting the Bankers Associations’ motion for summary judgment and denying the state’s cross-motion for summary judgement.  The judge agreed with the taxpayers that, although the tax was facially neutral, the purpose and effect of the tax was discriminatory against out-of-state banks.  The judge appears to have been persuaded by legislative history documents, including statements by individual legislators during a House floor debate, that the tax was meant to fall on out-of-state banks, as well as the practical effect that the tax would fall predominately on out-of-state banks.  The judge found that the Commerce Clause was designed to prevent this exact type of legislative action i.e., laws favoring in-state businesses over out-of-state businesses.

On May 22, 2020, the state filed a motion for reconsideration, arguing that the 1.2% B&O surtax does not violate the Commerce Clause because it applies equally to in-state and out-of-state financial institutions.  The state asserts that the Bankers Associations failed to meet their burden to prove that the tax discriminated against interstate commerce in favor of Washington’s economic interests and that the tax measure serves a legitimate, nondiscriminatory legislative purpose.  The state’s motion for reconsideration is currently noticed for hearing for June 4, 2020.