PROVISIONS DESIGNED TO ENHANCE GOVERNMENT OF THE VIRGIN ISLANDS FISCAL INDEPENDENCE
JUDICIAL INTERPRETATION OF SECTION 28
A PRESENTATION BY JOANNE E. BOZZUTO, ESQ. CPA
FOR THE UNIVERSITY OF THE VIRGIN ISLANDS AD HOC COMMITTEE
ON THE 1954 REVISED ORGANIC ACT
A BRIEF LOOK AT JUDICIAL INTERPRETATION OF SECTION 28
Various provisions of the Revised Organic Act of 1954 ("ROA") codified tax policies and provided revenue sources that had the objective of making the Government of the Virgin Islands more fiscally self sufficient and less dependent on the Federal government. The stated economic purpose of the Act was to increase the political and economic autonomy of the islands. The Senate report touted the bill as "a step forward toward the day when the Virgin Islands could be self-sustaining." See S. Rep. No 1271, 83d Cong., 2d Sess. (1954).
The Third Circuit Court of Appeals has often observed that it was the legislative intent that the Revised Organic Act should become a new basic charter of government for the Virgin Islands to take place of the somewhat makeshift Organic Act of 1936 which had proved unnecessarily cumbersome and inefficient and that the new Act should grant a greater degree of autonomy, economic as well as political, to the people.
Perhaps the most significant government revenue source incorporated into the 1954 Revised Organic Act was section 28. This section, together with a variety of local taxes, was to provide a reliable stream of tax revenue for the operation of the local government. While the section 28(a) did provide much needed revenue, it is a single run on sentence that is perhaps most exceptional for the sheer volume of litigation it generated. As of 2005, several of its major provisions have either been repealed by Congress or limited by judicial interpretation.
As amended, § 28(a) of the ROA (48 U.S.C. §1642) states:
The proceeds of customs duties, the proceeds of the United States income tax, the proceeds of any taxes levied by the Congress on the inhabitants of the Virgin Islands, and the proceeds of all quarantine, passport, immigration, and naturalization fees collected in the Virgin Islands shall be covered into the Treasury of the Virgin Islands, and shall be available for expenditure as the Legislature of the Virgin Islands may provide: Provided, That the term "inhabitants of the Virgin Islands" as used in this section shall include all persons whose permanent residence is in the Virgin Islands, and such persons shall satisfy their income tax obligations under applicable taxing statutes of the United States by paying their tax on income derived from all sources both within and outside the Virgin Islands into the treasury of the Virgin Islands: "
If section 28 was intended to be a clear long-term source of reliable government funding it proved to be something quiet different. The language of the statute and its interaction with other federal taxing statutes resulted in two major rounds of litigation, first, with the Federal government with respect to subparagraphs (a) and (b), and then, with over one hundred US corporations that had become "inhabitants" of the Virgin Islands under subparagraph (a). In the first round of section 28 litigation the Virgin Islands sued the Secretary of the Treasury for gasoline tax revenues and customs duties collected by the United States Treasury that it claimed should have been covered into the treasury of the Virgin Islands. Later, in the mid 1980s and early 1990s the Virgin Islands litigated dozens of cases with corporate taxpayers who claimed to be inhabitants of the Virgin Islands, took the position that they were required to file income tax returns exclusively with the Virgin Islands Bureau of Internal Revenue, and argued that they were not subject to corporate income tax on their non Virgin Islands (usually United States) source income. The litigation and its consequences are reviewed below.
THE COVEROVER LITIGATION
In the late 1970s and through the early 1980s the Government of the Virgin Islands found itself in the unenviable position of suing the United States Government to compel it to cover over gasoline taxes and customs duties imposed on products imported to the United States from the Virgin Islands. After winning on summary judgment in the United States District Court for the District of Columbia, the Virgin Islands Government ultimately lost in the United States Court of Appeals for the District of Columbia and has since been unable to recover gasoline taxes. Moreover, pursuant to the decision the cover over of customs duties is limited to duties imposed on products imported into the Virgin Islands. The Supreme Court of the United States denied certiorari on both issues.
Puerto Rico and the Virgin Islands both brought actions against the Secretary of the Treasury seeking gasoline revenues retained by the United States derived from a tax of 4¢ per gallon imposed by the United States on the initial sale of gasoline in the United States by a producer or importer. In 1966 the Virgin Island began to refine gasoline for sale in the United States and all such gasoline sold in the United States was subject to the 4¢ per gallon gasoline tax. The District Court asserted that the cover over provision was clear and unambiguous. The District Court held that the cover over provision by its terms was all-inclusive and should be interpreted broadly. The District Court granted summary judgment for the Virgin Islands, and concluded that the gasoline tax revenues must be covered over. It stated that the gasoline tax was in all respects similar to the liquor taxes that had traditionally been covered over. The impact of this decision was significant since the U.S. Customs Service's estimate of the amount of customs duties on petroleum products imported onto the United States from the Virgin Islands from 1966 through 1976 when the litigation commenced was over $97 million.
The Court of Appeals consolidated the Puerto Rico and Virgin Islands gasoline tax cases when the Federal government appealed and considered both cases together because it considered the cover over statute upon which the Virgin Islands relied to be identical in all essential aspects to that of Puerto Rico. In reversing the District Court for the District of Columbia, the Court of Appeals began by observing that the cover over provision was not "clear and unambiguous", contrary to the District Court's assertion, but rather was "replete with ambiguities." Primary among the ambiguities it found was the meaning of "all taxes" in section 28(b) in the context of the cover over provision. The Court of Appeals went on the say that given the initial ambiguity of "all taxes", the modifying phrase "on all articles produced in the Virgin Islands and transported to the United States" assumed critical importance. The Court of Appeals then found that the modifying phrase was also ambiguous. Having found the cover over provision "highly ambiguous" the Appeals Court resorted to traditional statutory interpretation aids such as legislative history and administrative construction. After focusing only on the Puerto Rico cover over statute and its legislative history, the Court held, first, that Congress intended to cover over only those taxes laid for equalization purposes and second, that the gasoline tax statute was not such a tax. It reversed the District Court and ordered it to enter judgment in the consolidated case in favor of the United States.
The gasoline tax cover over litigation is disconcerting in at least two respects. First, it is somewhat perplexing how one court can find a statute "clear and unambiguous" while another court reading the same statute can find it "highly ambiguous." Second, assuming that the highest court to decide the issue is correct, and further that tax revenue is the life blood by which a
ny government renders essential services, the logical conclusion is that after fifty years the Virgin Islands cover over relationship with the Federal government regarding essential tax revenue is still governed by a "highly ambiguous" law.
The Federal appeal of the Virgin Islands customs duty case did not involve Puerto Rico and was decided separately in a companion opinion. The Virgin Islands faired no better.
The Virgin Islands had brought suit in the United States District Court for the District of Columbia against the Secretary of the Treasury seeking judgment that proceeds of the customs duty collected on goods entering the United States by shipment from the Virgin Islands was to be covered over to the Virgin Islands treasury. The District Court held that section 28(a) of the Revised Organic Act of the Virgin Islands required the Secretary of the Treasury to cover over into the treasury of the Virgin Islands all customs duties collected on goods transported into the United States from the Virgin Islands. In rejecting the federal government's argument that a rebate of duties on goods that merely passed through the Virgin Islands would be "illogical," the District Court concluded: "(I)t is (even) more illogical (to assert) that Congress intended to cover over only the meager customs duties levied on goods imported into the Virgin Islands. As discussed earlier, these goods traditionally have entered the Virgin Islands almost duty free and the amount of revenue from duties imposed on such goods would be negligible. It would be surprising if Congress intended that only the insubstantial amount of duties collected on imports into the Virgin Islands be covered into the Virgin Islands Treasury."
The District Court hit the nail on the head with that observation. To this day customs duties imposed at entry to the Virgin Islands are collected by the United States Customs Service whose employees who are by United States law required to transmit the monies collected to the United States treasury. Proceeds of locally collected customs duties "less the cost of collecting such duties" as provided in section 28(a) have in recent years provided minimal revenue to the Government of the Virgin Islands. One could reasonably argue that a tax that costs almost as much to collect as the total revenue it generates is a tax that serves no useful purpose. Additionally, one could argue that a tax collected by an entity that has no incentive to do so efficiently or effectively should, at a minimum, be collected subject to a fixed maximum percentage cost of collection and not simply governed by a "highly ambiguous" statute.
In any event, the Court of Appeals held that the Secretary was required to cover over only locally collected customs duties and not all customs duties collected on goods transported into the United States from the Virgin Islands. As previously noted, the Supreme Court of the United States declined to review the matter.
This Court of Appeals decision provides an excellent example of the importance of self-governance in advocating the rights of the Territory arguably provided by Congress to achieve the goal of fiscal stability. The Appeals Court found that a long-standing Treasury administrative practice was controlling. The Appeals Court noted that in 1936 Congress had amended the language of the 1917 Act on which the Comptroller of the Treasury had originally relied to deny the cover over of the disputed customs duties and, further, that the United States Department of Interior had objected to Treasury's position in 1941. The Appeals Court noted that apart from the position taken by the Interior Department in 1941, objections to the consistent administrative interpretation by Treasury appeared to have lain dormant for more than a half century. Finally, the Appeals Court observed that "the active interest which resurfaced in the 1970's may have been attributable to the greater autonomy conferred upon the Islands government by recent acts of Congress" noting the election of a democratically selected Governor for the first time on November 3, 1970. Indeed the Court's observation is well-founded. It seems highly unlikely that the Department of Interior, having been officially rebuffed, would have had an incentive to or a practicable process for pursuing the issue beyond an exchange of correspondence with Treasury and the United States Justice Department. As a practical matter, given the extraordinary amount of money at stake and the passage of so much time since the enactment of the statutes at issue, the Virgin Islands litigation was a well-fought uphill battle. The Courts may or may not have provided the Virgin Islands with the "step forward" toward fiscal self-sufficiency that Congress actually intended.
THE 28(a) COMPANY LITIGATION
In the 1980's the Government of the Virgin Islands again found itself embroiled in litigation this time with scores of corporate taxpayers over the proper income tax liability to be paid to the Virgin Islands under ROA section 28(a). Over one hundred U.S. incorporated taxpayers had claimed to be inhabitants of the Virgin Islands and took the position that they were only required to file income tax returns with the Virgin Islands Bureau of Internal Revenue (not the IRS), and claimed that they were not subject to corporate income tax on their non-Virgin Islands (usually United States) source income. The perception of a major potential "tax loophole" prompted Congress to repeal the so-called "inhabitant rule" in the Tax Reform Act of 1986. Since 1987 the Virgin Islands has lost the right to tax the United States source income of U. S. corporations headquartered in the Virgin Islands. The Virgin Islands ultimately established that there never was a "tax loophole" after scores of district court cases, multiple appeals to the Third Circuit Court of Appeals and three taxpayer petitions to the Supreme Court of the United States. While the Virgin Islands collected over $60 million from "28a companies", it lost the right to tax the worldwide income of U.S. corporations "inhabitant" in the Virgin Islands after 1986.
The impact of section 28(a) on Virgin Islands inhabitants' income tax obligations was thoroughly examined by the Third Circuit Court of Appeals in the of Danbury, Inc. v. Olive, 820 F.2d 618 (3d Cir 1987). In contrast to the cover over litigation, the Third Circuit Court of Appeals found that the plain language to section 28(a) prohibited the position taken by these corporations. Stating that the language of the section was "unambiguous", the Court found that the section did not affect the total amount of tax owed by such a corporation, but it did direct the corporation to pay its total tax liability under both the mirrored and non-mirrored versions of the Internal Revenue Code into the Virgin Islands treasury.
The Court of Appeals further held that the rule that inhabitants of the Virgin Islands satisfy their tax obligations to the United States by paying their income taxes to the Virgin Islands in accordance with the provisions of § 28(a) of the ROA was repealed by Congress in the Tax Reform Act of 1986. It is important to note that the Revised Organic Act of 1954 language has not been amended; rather a separate federal statute has effectively repealed the provision cited above. Because the ROA is a federal statute, later enacted federal statutes that conflict with the ROA supersede the ROA provisions unless Congress specifically provides otherwise. The "inhabitant rule" of § 28(a) of the ROA with respect to income taxes was repealed in 1986 by the Tax Reform Act of 1986 ("TRA 86") that amended §7651(5)(B) of Title 26 (the United States Internal Revenue Code).
Prior to TRA 86 that section stated:
For purposes of this title, Section 28(a) of the Revised Organic Act of the Virgin Islands shall be effective as if such section had been enacted subsequent to the enactment of this title. (Emphasis
After TRA 86 Title 26 U.S.C. §7651(5)(B) read:
For purposes of this title, Section 28(a) of the Revised Organic Act of the Virgin Islands shall be effective as if such section 28(a) had been enacted before the enactment of this title and such section 28(a) shall have no effect on the amount of income tax liability required to be paid by any person to the United States. (Emphasis added).
Congress stepped in to change the law while the Danbury case was on appeal. Despite the Virgin Islands prevailing in that litigation, the net result of the "tax loophole" controversy was the permanent loss of the Virgin Islands' right to tax worldwide income of US corporations inhabitant in the Virgin Islands.
PRESENT REVENUE EFFECT OF SECTION 28
Fifty years after its enactment section 28 has no effect on the income tax liability of any person. The income tax laws of the Virgin Islands are governed by the United States Internal Revenue Code as made applicable to the Virgin Islands by the Naval Services Appropriation Act of 1921.
Although gross customs duty collections in recent years have been millions of dollars, the federal operating costs for collecting these duties locally is reported to be essentially equal the total revenue. Relatively little net revenue is generated from customs duties for cover over to the Government of the Virgin Islands.
Rum is the principal article presently produced in the Virgin Islands and exported to the United States that is subject to federal excise tax that qualifies for transfer to the Virgin Islands government under section 28(b). The rum excise matching fund revenues currently approximate $70 million annually and are used to back Virgin Islands bond issues that provide funding for capital projects.
With the exception of the rum excise matching funds, section 28 no longer generates significant revenue for the Virgin Islands government. From the date of its enactment federal administrative practices, judicial interpretations and subsequent Congressional legislation have operated together to limit the all-inclusive language of the section. The sweeping cover over of "all taxes" under 28(b) was not what it appeared to be.
Editor's note: Joanne E. Bozzuto is a member of the University's Ad Hoc Committee and an attorney at the VI Department of Justice.
Editors note:We welcome and encourage readers to keep the dialogue going by responding to Source commentary. Letters should be e-mailed with name and place of residence to [email protected].