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Case of the State Tax on Foreign-Held Bonds, 82 U.S. 15 Wall. 300 300 (1872)

Case of the State Tax on Foreign-Held Bonds

82 U.S. (15 Wall.) 300


1. The power of taxation of a state is limited to persons, property, and business within her jurisdiction. All taxation must relate to one of these subjects.

2. Bonds issued by a railroad company are property in the hands of the holders, and when held by nonresidents of the state in which the company was incorporated, they are property beyond the jurisdiction of that state. A law of Pennsylvania, passed on the 1st of May, 1868, which requires the treasurer of a company, incorporated and doing business in that state to retain five percent of the interest due on bonds of the company, made and payable out of the state to nonresidents of the state, citizens of other states, and held by them, is not, therefore, a legitimate exercise of the taxing power of the state. It is a law which interferes between the company and the bondholder, and, under the pretense of levying a tax, impairs the obligation of the contract between the parties.

3. The exemption from taxation by the State of Pennsylvania of bonds thus issued to and held by nonresidents of that state, citizens of other states, is not affected by the fact that the bonds are secured by a mortgage, executed simultaneously with them, upon property situated in that state. A mortgage there, though in the form of a conveyance, is a mere security for it debt, and transfers no estate in the mortgaged premises. It simply creates a lien upon them, and only confers upon the holder, or the party for whose benefit the mortgage is given, a right to proceed against the property mortgaged, upon a given contingency, to enforce the payment of his demand. This right has no locality independent of the party in whom it resides.

4. The tax laws of it state can have no extraterritorial operation, nor can any law of it state inconsistent with the terms of a contract, made with or payable to parties out of the state, have any effect upon the contract whilst it is in the hands of such parties or other nonresidents of the state.

The plaintiff in error in this case, the Cleveland, Painesville & Ashtabula Railroad Company, was incorporated by an act of the legislature of Ohio passed in 1848, and authorized to construct a railroad from the City of Cleveland in that state to the line of the State of Pennsylvania. Under

Page 82 U. S. 301

this act and its supplement, passed in 1850, the road was constructed. By an act of the Legislature of Pennsylvania passed in 1854, the company was authorized to construct a railroad from the City of Erie in that state to the state line of Ohio, so as to connect with this road from Cleveland, and also to purchase a railroad already constructed between those points. This grant of authority was subject to various conditions, which the company accepted, and under its provisions the road between the points designated was constructed, or the one already constructed was purchased, and connected with the road from Cleveland, so that the two roads together formed one continuous line between the Cities of Cleveland and Erie. The whole road between those places was ninety-five and a half miles in length, of which twenty-five miles and a half were situated in the State of Pennsylvania and the rest, seventy miles, were situated in the State of Ohio. The company, so far as it acted in Pennsylvania under the authority of the act of her legislature, has been held by her courts to be a separate corporation of that state, and as such subject to her laws for the taxation of incorporated companies. [Footnote 1] But there was only one board of directors who managed the affairs of both companies as one company, and had the entire control of the whole road between Cleveland and Erie.

In 1868, the funded debt of the company amounted to $2,500,000 and was in bonds of the company secured by three mortgages, one for $500,000, made in 1854, one for $1,000,000, made in 1859, and one for $1,000,000, made in 1867. Each of the mortgages was executed upon the entire road, from Erie, in Pennsylvania, to Cleveland, in Ohio, including the right of way and all the buildings and other property of every kind connected with the road. The principal and interest of the bonds first issued were payable in the City of Philadelphia; the principal and interest of the other bonds were payable in the City of New York. All the bonds were executed and delivered in Cleveland, Ohio,

Page 82 U. S. 302

and nearly all of them were issued to, and have been ever since held and owned by nonresidents of Pennsylvania and citizens of other states. The interest was at 7 percent

On the 1st of May, 1868, the Legislature of the State of Pennsylvania passed an act entitled "An act to revise, amend, and consolidate the several laws taxing corporations, brokers, and bankers," the eleventh section of which provided as follows:

"The president, treasurer, or cashier of every company, except banks or savings institutions, incorporated under the laws of this Commonwealth, doing business in this state, which pays interest to its bondholders or other creditors, shall, before the payment of the same, retain from said bondholders or creditors, a tax of five percentum upon every dollar of interest paid as aforesaid, and shall pay over the same semiannually, on the first days of July and January in each and every year, to the state treasurer for the use of the Commonwealth, and every president, treasurer, or cashier as aforesaid shall annually, on the thirty-first day of each December, or within thirty days thereafter, report to the auditor general, under oath or affirmation, stating the entire amount of interest paid by said corporation to said creditors during the year ending on that day, and thereupon the auditor general and state treasurer shall proceed to settle an account with said corporation as other accounts are now settled by law."

The treasurer of the company, under this act, made a report in May, 1869, showing that during the previous year the company had paid interest on its funded debt of $2,500,000, at the rate of 7 percent, amounting to $175,000. Upon this report the auditor general and state treasurer "settled an account" against the company, finding that it owed to the state the sum of $2,336.50 for the tax on the interest which the company had paid.

In reaching this conclusion, these officers apportioned the interest upon the debt owing by the company according to the length of the road, assigning to the part in the State of Pennsylvania an amount in proportion to the whole indebtedness which that part bears to the whole road. There was

Page 82 U. S. 303

no law, however, in existence at the time directing or authorizing this proceeding.

From the settlement thus made the company appealed, under the law of the state, to the court of common pleas of one of her counties, specifying various objections to the settlement, and among others substantially the following:

That the greater portion of the bonds of the company having been issued upon loans made and payable out of the state, to nonresidents of Pennsylvania, citizens of other states, and being held by them, the act in question, in authorizing the tax upon the interest stipulated in the bonds, so far as it applied to the bonds thus issued and held, impaired the obligation of the contracts between the bondholders and the company, and is therefore repugnant to the Constitution of the United States and void.

The contest in the Court of Common Pleas took the form of a regular judicial proceeding, a declaration having been filed by the attorney general on behalf of the state against the company as for a debt and the company having joined issue by a plea of non-assumpsit and payment. The common pleas sustained the validity of the alleged tax against the objections of the company, and verdict and judgment passed in favor of the state. On error to the supreme court of the state, the judgment was affirmed, and the case is brought here for review under the second section of the amendatory Judiciary Act of 1867.

The judgment of the Supreme Court of Pennsylvania in the case now brought here was rested, it may be well to say, upon a prior decision of that court -- one made in Maltby v. Reading & Columbia Railroad Co. [Footnote 2] That case was thus: an Act of the Legislature of Pennsylvania of April 29, 1844, by its 32d section, laid a tax on "mortgages, money owing by solvent debtors, whether by promissory notes, penal or single bill, bond or judgment," and a following section required the commissioners of the county to assess a tax of three mills on every dollar of the value of property made liable

Page 82 U. S. 304

by the 32d section to taxation. Several years prior to 1864, the Reading & Columbia Railroad Company, a corporation of Pennsylvania, issued bonds payable with semiannual interest at 7 percent. On the 30th of April, 1864, the Legislature of Pennsylvania passed an act which required the president &c., of any corporation which pays interest on which a state tax is imposed, "before payment of the same to retain the state tax," and pay the same to the treasurer of the state. Maltby, a holder of certain coupons due before 1864, presented them to the railroad company for payment. The company insisted on retaining the tax of three mills on each dollar of the bonds. On suit by Maltby, a nonresident of Pennsylvania, he asserted that the tax on "money owing by solvent debtors" was a tax on the debt in the hands of its holder -- in other words, in the hands of the creditor, and not in the hands of the debtor -- and that he, the holder in this case, being a nonresident of Pennsylvania, the debt followed his person and could not be taxed; moreover, that the tax, if it taxed the debt in the hands of the creditor, impaired the obligation of contracts. The Supreme Court of Pennsylvania decided all three points against Maltby, the creditor.

Woodward, C.J., for the said court, in answering the argument that the holder of the bond was a nonresident of the state, and the tax on the debt was therefore illegal, and the other argument, to-wit, that the retention of the tax out of the coupon violated the obligation of a contract, said:

"As to the nonresidence of the holder of the loan. It is undoubtedly true that the Legislature of Pennsylvania cannot impose a personal tax upon the citizen of another state, but the constant practice is to tax property within our jurisdiction which belongs to nonresidents. Our land taxes have always been imposed without regard to the domicile of the owner, and so have the taxes of stocks in banks and other incorporated companies. Stocks and loans are personal property, and the domicile of the owner determines the rights of succession to such property, though its situs at the time of his death determines the right of administration, but the legislative power of taxation does not

Page 82 U. S. 305

depend upon these distinctions. There must be jurisdiction over either the property or the person of the owner, else the power cannot be exercised; but where the property is within our jurisdiction, and enjoys the protection of our state government, it is justly taxable, and it is of no moment that the owner who is required to pay the tax resides elsewhere. The duties of sovereign and subject are reciprocal, and any person who is protected by government in his person or property may be compelled to pay for that protection."

"The principle of taxation as the correlative of protection, perfectly just in itself, is as applicable to a nonresident as to a resident owner, because civil government is essential to give value to any form of property, without regard to the ownership, and taxation is indispensable to civil government. What would this plaintiff's loan be worth if it were not for the franchises conferred upon the company by the Commonwealth, franchises which are maintained and protected by the civil and military power of the Commonwealth? Is it not apparent that the intrinsic and ultimate value of the loan as an investment rests on state authority -- that it is the state which made it property and preserves it as property? Then it would seem that this kind of property, more than any other, ought to contribute to the support of the state government. And I suppose it is upon this ground that the legislature discriminates between corporation loans and private debts as objects of taxation. The artificial debtor, itself a creature of the legislative power, and all its functions derived from legislative grant, is so dependent upon the government, it lives and moves and has its being so entirely by the favor of the government, that not only what it owns, but what it owes also, is thought fit to be taxed, whilst only the possessions of the natural person, and not his debts, are taxed."

"But it may be said, and indeed was urged in argument, that the plaintiff's loan as personal property follows his person, and is property for all purposes only in the place where he has his domicile. For some purposes, as already intimated, it is undoubtedly subject to the law of the domicile, and yet in a very high sense it is also property here in Pennsylvania. It was admitted in argument that corporation stocks are property here though owned beyond our jurisdiction, and this is a necessary consequence of the final ruling which a long-vexed question in the

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Supreme Court of the United States received in the case of Ohio & Mississippi Railroad Company v. Wheeler, [Footnote 3] where it was held that stockholders in railroad companies become presumptively citizens of the state which creates the corporation. Property has been defined to be the right or interest which one has in lands or chattels, and so domestic is this peculiar species of property that it domesticates the owner. But loans are not stocks, and yet the loans and stock of a railroad company resemble each other in many respects. Both are subscribed under the authority of a special law, and both are so far capital that they are employed for the same general purposes. The certificate of stock, which the plaintiff as a citizen of Rhode Island may hold for shares in this company, is mere paper evidence of property existing here; it is not the thing signified, it is only evidence of it. Is the bond which the plaintiff holds anything more? He cannot enforce it where he lives; he must come here to gather its fruits. It is founded upon and derives its value from a mortgage, but that mortgage is here, and the franchises and properties which the mortgage binds are here within our jurisdiction. The bond signifies his right to receive so much money out of the mortgaged estate, but that estate not only belongs to our jurisdiction, but was in part created by our authority, and the power to raise the mortgage, like all the franchises of the company, was conferred by state authority."

"Now although loans and stocks are distinguishable for many purposes, yet the legislature committed no very great solecism in treating loans as taxable property within our jurisdiction. The tax may be thought to be extravagant, especially in view of the taxation to which the owner is exposed in the place of his residence, but that is a consideration for legislative attention. The point we rule upon this part of the case is that corporation loans, though in some sense mere debts, are like moneys at interest, taxable as property, and moneys at interest have long been taxed in Pennsylvania."

"Then has the company the right to deduct the tax from the coupons? This, it is said, violates the faith of the obligation, and renders all such legislation void. How far modern tax laws shall be permitted to impair and alter private contracts is a great question, which must be decided ultimately by the Supreme

Page 82 U. S. 307

Court of the United States. I have my own private opinions, which would probably be found to differ from a majority of this court. Perhaps the sound conclusion is that governmental taxation, a thing always to be anticipated when contracts are made, does not impair the obligation of contracts within the meaning of the constitutional inhibition. If this be conceded as a principle, then the mode of collecting the tax, whether by a government agent, a debtor corporation or manufacturer, is mere machinery, and involves no principle whatever. For the present, therefore, and speaking for the court, I lay it down that the acts of assembly to which I have referred are constitutional and valid; that they tax the loan as property found here in Pennsylvania, and that they appoint the debtor corporation the collector of that tax for the benefit of the state government. "

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