A Lesson in Legal Strategy: CSX v. Alabama Department of Revenue

Roxanne Bland

Roxanne Bland is Tax Notes State’s contributing editor. Before joining Tax Analysts, Bland spent 17 years with the Multistate Tax Commission, where she worked with state revenue agency representatives to draft model legislation pertaining to sales and use taxation and corporate income, analyzed and reported on proposed federal legislative initiatives affecting state taxation, worked with legislative consultants and representatives from other state organizations on international issues affecting states, and assisted member state representatives in federal lobbying efforts. Before that, she was an attorney with the Federation of Tax Administrators for over seven years.

In this installment of The SALT Box, Bland discusses the basis of crafting a solid litigation strategy.

Crafting a litigation strategy in the battle between taxpayer and state is not an easy task, and the more complex the case is, the more difficult it becomes. There are many factors to consider, but the most important is likely the client (whether it be the taxpayer or the state) and managing expectations from a judicial outcome. Once a trial court renders its decision, an appeal may be taken by either party. Thereafter, depending on the appellate court’s ruling, a second appeal may ensue. And it does not necessarily stop there — a higher court may remand the matter to the lower court for reconsideration, or a party might take an appeal from the decision on remand, and the chess game continues.

If the state loses its lawsuit, further perils can await. There may be other taxpayers in the wings with similar grievances, waiting for the suit’s final determination. On that date or soon thereafter, these new plaintiffs step out of the shadows and file suit against the state, which may be bound by statements it made in its pleadings in the previous litigation. That’s what happened to Alabama in BNSF.¹ Originally filed in 2011, BNSF Railway Co. complained that the state’s imposition of sales and use tax on diesel fuel purchased by railroads but not motor carriers or water vessels violated the Railroad Revitalization and Regulatory Reform (4R) Act, the same issue involved in the then-ongoing litigation between Alabama and CSX Transportation Inc.² By 2016 five additional railroads had filed suit against Alabama on the same issue, and the cases were consolidated. The actions remained pending until the state and CSX reached final resolution in 2019. At this time, the plaintiffs moved forward, seeking the same relief as that awarded to CSX.

The Saga of Alabama, CSX, and the 4R Act

To say that the road to CSX’s final win over Alabama was a tortuous one would be an understatement. Spanning 10 years, the matter went before the federal district court three times, the Eleventh Circuit five times, and the U.S. Supreme Court twice. For this article, it will be useful to briefly recapitulate CSX’s procedural history. On its initial foray into the federal district court, CSX’s complaint alleged that Alabama’s imposition of sales and use tax on its purchases of diesel fuel but not on its competitors’ — motor carriers and water carriers — was discriminatory, in violation of the 4R Act. The company sought a declaratory judgment that the sales and use tax was discriminatory as applied to railroads, and to enjoin the state from collecting the tax from or on behalf of CSX. In its answer to the company’s complaint, Alabama, aside from its contention that the sales and use and motor fuels excise tax structure passed muster under the 4R Act, made a broad admission that motor carriers and water carriers were the railroad transport industry’s principal competitors in the state. The district court stayed the CSX action, pending the resolution of Norfolk Southern³ in the Eleventh Circuit. In 2008 the appellate court of Norfolk Southern concluded that the state’s tax scheme did not violate the 4R Act because (1) the 4R Act’s subsection 11501(b)(4) does not support a claim for discriminatory exemptions; and (2) the sales and use tax did not target railroads because the tax was generally applied to all purchases of diesel fuel, including to intrastate water carriers and motor carriers that had not paid the fuel tax. The group of taxpayers exempt from the tax, such as governmental entities, commercial fishing vessels, manufacturers, and other industries was not large enough to constitute discrimination. Later, the federal district court dismissed the CSX litigation sua sponte, and the Eleventh Circuit affirmed.⁴ CSX appealed to the Supreme Court, which ruled that the term “another tax” in subsection 11501(b) applies to sales and use tax, and that a state’s tax exemptions can be challenged as discriminatory under that subsection.⁵ The Court remanded the matter for a redetermination of CSX’s discrimination claim.

Before the federal district court a second time, Alabama again stipulated that the rail carriers’ principal competitors were motor carriers and water carriers. The district court ruled for the state, finding that the sales and use tax was not discriminatory because although the sales and use tax rate for rail carriers and the motor fuels tax rates for motor carriers were different, the two paid substantially similar amounts in tax, so the state provided sufficient justification for the disparate treatment. Further, foreign commerce clause concerns provided a rational basis for exempting water carriers from the sales and use tax, the court explained.⁶ The Eleventh Circuit reversed, rejecting Alabama and the district court’s justification for the discrimination because, it said, courts are ill-equipped to evaluate the overall fairness of the state’s tax structure. The court did not address the water carrier question, stating only that those carriers paid no tax. Finally, it answered a question raised neither by the Supreme Court’s prior opinion nor the litigants — that is, the appropriate comparison class for a determination of whether the sales and use tax discriminated against rail carriers. It found the proper comparison class to be the rail carriers’ competitors — motor carriers and water carriers — rather than the class of commercial and industrial taxpayers that pay sales and use tax on diesel fuel.⁷ The Supreme Court agreed with the Eleventh Circuit that the proper comparison class for CSX’s discrimination claim was the competitors. However, it reversed the circuit court’s refusal to consider the discrimination claim vis-à-vis motor carriers and remanded with further instructions to determine if the state could provide justification for exempting water carriers from both taxes.⁸

In the CSX’s third and final round before the district court, the court determined that based upon the evidence, the sales and use tax on diesel fuel paid by rail carriers and the motor fuels tax paid by motor carriers were roughly equivalent, and the discrimination of which CSX complained was its own doing. Second, it found that Alabama’s failure to exempt water carriers from tax could violate the commerce clause. Finally, the court determined that the exemption caused no competitive injury to rail carriers.⁹ The Eleventh Circuit agreed with the district court that the sales and use tax and the motor fuels tax were roughly equivalent and that the exemption of motor carriers from sales and use tax was justified. However, it found no such justification for exempting water carriers under federal law, adding that the tax exemption discriminated against rail carriers in violation of the 4R Act regardless of competitive injury.¹⁰

This recounting of CSX’s procedural history illustrates that at no stage during the litigation proceedings did Alabama retreat from its position of the rail carriers’ principal competitors being motor carriers and water carriers. This would come back to haunt it, at least as concerned water carriers. While CSX was in litigation, BNSF and five additional plaintiffs filed suit under the 4R Act between 2011 and 2016, alleging the same discriminatory taxation. Once CSX became final, Alabama argued that the Eleventh Circuit’s finding that the exemption for water carriers discriminated against CSX applied only to CSX, and not BNSF or its co-plaintiffs because there was no evidence introduced in the latter cases that the water carrier exemption discriminated against the plaintiffs. Of course, the state’s assertion was belied by the unbroken line of stipulations in CSX that its arguments applied to rail carriers in the plural. It appears, then, that the state’s legal strategy was to make a broad stipulation in anticipation of prevailing in the CSX litigation, and then relying on the final decision to dispose of the claims made by BNSF and the remaining litigants. Unfortunately for the state, CSX was victorious. The state’s backpedaling from its several stipulations was to no avail, and the BNSF court held that Alabama was judicially estopped from litigating the water carrier question.

In hindsight, one has to question why Alabama was so confident that its litigation strategy would prevail in CSX. This litigation concerned questions that no court had answered before, such as whether exemptions could be litigated under subsection 11501(b)(4). Considering that the subsection has virtually no legislative history, importing the Supreme Court’s ACF¹¹ holding of property tax exemptions under subsection 11501(b)(4) was a stretch, as the Court so explained in CSX I, and that, it seems, was the point at which Alabama’s litigation strategy began to fall apart. If Alabama had prevailed here, there would have been no BNSF. It did not, and with CSX continuing to litigate, it was able to probe further into questions such as the proper comparison class and whether there existed a rough equivalence between the sales and use tax and the motor fuels tax. While Alabama won the day regarding the motor fuels tax, the sales and use tax exemption for water carriers was its downfall. Because the Supreme Court ruled against it in CSX I, Alabama was forced to scramble for grounds supporting the water carrier exemption, but based on the arguments it presented, the state does not appear to have considered those reasons before CSX I. If Alabama had prevailed in that case, there would never have been a need to do so — but, again, it did not. If it could try again, would the state do anything different?

Conclusion

Developing a litigation strategy is arguably an art form. There are many factors to consider, many questions concerning the law applicable to the facts, anticipating the opposing party’s arguments, and the ability to respond quickly to unexpected developments. However, as the CSX saga demonstrates, when crafting a litigation strategy, it is never helpful to be overly confident of one’s position, especially where questions of law have not been addressed by a court. It is a lesson to be learned — no matter how well prepared one thinks one is, victory is never assured.