66 N.Y.2d 243 (1985)
r
r
A city tax law that effectively places a greater tax burden on holders of federal obligations compared to holders of other obligations, such as those of other states or certain corporate bonds, impermissibly discriminates against federal obligations and violates federal law (31 U.S.C. § 3124) and the Supremacy Clause of the U.S. Constitution.
r
r
Summary
r
Forbes, Inc. challenged New York City’s General Corporation Tax, arguing it discriminated against federal obligations. The City’s tax law allocated investment income based on the issuer’s connection to the city. However, the method for calculating the investment allocation percentage (IAP) and the application of an “18% rule” placed a greater burden on taxpayers holding federal obligations, making them less attractive investments. The Court of Appeals held that the city’s tax law was discriminatory, violating federal law and the Supremacy Clause, because it did not treat federal obligations as favorably as other types of investments.
r
r
Facts
r
Forbes, Inc. invested in corporate obligations (Sheraton and Alabama Power), U.S. Treasury obligations, and held bank accounts. For the 1978 tax year, Forbes’s investment portfolio was heavily weighted towards U.S. obligations. The City’s tax law allows for allocation of investment income based on the business allocation percentage (BAP) of the issuer of corporate obligations. The City audited Forbes’s tax returns and adjusted the IAP, excluding Forbes’s investment in Sheraton obligations, which reduced Forbes’s IAP to zero. The City then allocated Forbes’s investment income based on Forbes’s BAP (60%) instead of its IAP (2.38%). This resulted in a significant increase in Forbes’s tax liability.
r
r
Procedural History
r
Forbes petitioned the Department of Finance for a redetermination of the additional assessment. An auditor testified that he applied an “18% rule” to exclude Forbes’s investments in Sheraton because the ratio of corporate obligations to total investments was less than 18%. The referee concluded that Forbes had not demonstrated an abuse of discretion by the Commissioner of Finance. The Appellate Division affirmed. Forbes appealed to the Court of Appeals.
r
r
Issue(s)
r
Whether New York City’s General Corporation Tax, as applied to Forbes, impermissibly discriminates against obligations of the United States in violation of 31 U.S.C. § 3124 (formerly § 742) and the Supremacy Clause of the U.S. Constitution.
r
r
Holding
r
Yes, because the City’s tax law effectively places a greater tax burden on holders of federal obligations compared to holders of other obligations, thereby diminishing the investment attractiveness of federal obligations.
r
r
Court’s Reasoning
r
The court reasoned that the City’s tax law discriminated against federal obligations in two ways. First, by excluding federal obligations from the denominator of the IAP calculation while including obligations of other states, the law effectively placed a greater tax on federal obligations. As the court stated, “Excluding Federal obligations from the denominator of the IAP, while including obligations of other States, effectively places a greater tax on the former than on the latter.” The court provided a hypothetical example demonstrating the disparity. Second, the “18% rule” penalized taxpayers who invested 82% or more of their capital in obligations other than certain corporate obligations, including federal obligations.
r
The court rejected the City’s argument that the tax had a rational basis and did not favor New York State obligations. It emphasized that the controlling issue under section 3124 is whether the tax adversely affects federal obligations compared to other obligations, regardless of the rationality of the tax scheme. Citing Memphis Bank & Trust Co. v Garner, 459 U.S. 392 (1983), the court stated that a “state tax that imposes a greater burden on holders of federal property than on holders of similar state property impermissibly discriminates against federal obligations.”