North Carolina Department of Justice
North Carolina Department of Justice
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Reply to: Revenue Section Telephone: (919) 733-3252 Fax: (919) 715-3550

June 23, 1999

The Honorable Bill Owens North Carolina General Assembly Suite 632 LOB 300 N. Salisbury Street Raleigh, North Carolina 27603-5925

Re: Advisory Opinion: Constitutionality of amendment to Proposed Committee Substitute for H.B. 1303; tax preferences for electronic shopping and mail-order houses; G.S. § 105-129.2 et. seq.

Dear Representative Owens:

You request our opinion as to the constitutionality of a possible amendment to the Proposed Committee Substitute for H.B. 1303. While the legislation is not yet in true bill form, the forwarded materials reflect that it will add new provisions to Article 3A of Chapter 105, G.S. § 105-129.2 et seq., commonly known as the “William Lee Act.” In essence, the Act confers various tax credits and other preferences for new and expanding businesses.

Specifically, the amendment will extend the existing tax benefits to establishments retailing merchandise by mail or electronic media. “Establishments” is narrowly defined as businesses inventorying products “to be used or sold by other establishments of the same enterprise.” Many of the operative terms and definitions are taken from the North American Industry Classification System, a reference manual published by the federal Office of Management and Budget. Consistent with other similar criteria presently required by Article 3A, establishments qualifying for preferences must also locate within designated enterprise areas, make minimum investments and create a fixed number of jobs.

In short, the amendment creates a new class of taxpayers eligible for Article 3A’s extensive tax benefits. Traditional “main street” retailers, i.e., businesses with stores for customers to visit, however, and nonstore retailers who accept customer calls directly rather than through a separate location of the business, or who sell through representatives providing in-home demonstrations, are excluded from the classification.

The requirements of “uniformity,” “equal protection,” and “due process” are practically the The Honorable Bill Owens

June 23, 1999

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same for either the state or federal constitutions. Realty Corp. v. Coble, Sec. of Revenue, 291

608, 617 (1977). The test for whether an economic regulation withstands equal protection scrutiny is the “rational basis standard.” In re Assessment of Taxes Against Village Publishing Corp., 312 N.C. 211, 222 (1984). An act provides equal protection if its classification “bears a rational relationship to a conceivable legitimate purpose.” White v. Pate, 308 N.C. 759, 766-67 (1983). As long as a classification is not arbitrary or capricious, but rather founded upon a rational basis, the distinction will be upheld by the Court.” Four County Membership Corp. v. Powers, 96
App. 417, 424 (1989).

The amendment appears free of commerce clause infirmities. Nothing we have examined in materials provided suggests the legislation would impermissibly favor local interests at the expense of interstate commerce. While the William Lee Act itself provides favorable tax attributes for business activity conducted within North Carolina, these benefits are available to all entities regardless of domicile or residency. In any event, the general constitutionality of Article 3A, enacted several years ago, is beyond the scope of this review.

Two aspects of the amendment might invite equal protection challenges by retailers not qualifying for benefits. The rationale for the legislation’s award of tax preferences to businesses selling via electronic media, but denial of benefits to main street vendors accepting walk-in customers, will need to be developed. As possible justification for this distinction, the reviewed materials suggest that mail order sales pull new money into a jurisdiction with a multiplier effect promoting business expansion and growth, thus furthering objectives of the William Lee Act. In contrast, we understand that traditional vendors merely compete witW The Honorable Bill Owens

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Candidly, since North Carolina courts have not yet addressed the validity in the tax area of either rationale, we cannot predict with any certainty how they would rule upon these issues. Nevertheless, as noted, they traditionally accord considerable deference to the lines set by the legislature in economic regulations.

Of greater concern to us is the further distinction drawn between establishments with separate distribution centers, and those with centralized operations. From the materials presented to us, we have been unable to identify a legitimate governmental objective served by a tax scheme which penalizes entities which consolidate their business activities, but rewards those which separate inventory or distribution centers from sales staff. Absent a rational basis, the distinction would not pass constitutional muster, and we suggest its elimination.

If the amendment were declared unconstitutional for any reason, the ruling likely would be retroactive. Harper v. Virginia Department of Taxation, 509 U.S. 86 (1993). In fashioning appropriate relief, the court might invalidate the entire scheme, order refunds to businesses which had not qualified for the credit or expand the class eligible to receive credits from merely mail order businesses to all retailers. Bailey v. State, 348 N.C. 130 (1998); Smith v. State, 349 N.C. 332 (1998).

You also inquire whether the legislature might be precluded later from narrowing or repealing the amendment, as occurred in Bailey. We do not believe Bailey implicates the amendment from this perspective. Bailey addressed distinctive features of employer-employee contract law, and rested upon unique reliance factors. In distinction, the William Lee Act is already scheduled for automatic repeal in the future, eliminating the reliance interests which so animated the Bailey decision.

We hope you find the foregoing helpful.


Reginald L. Watkins Senior Deputy Attorney General

George W. Boylan

Special Deputy Attorney General GWB:jmc