U.S. Court of Appeals Rejects DBS Challenge to Kentucky Taxation of Multichannel Video Sales and Revenues
On May 31, 2007, the United States Court of Appeals for the 6th Circuit issued a significant opinion1 for the cable industry, rejecting the constitutional challenge by DirecTV and EchoStar (collectively, “DBS Plaintiffs”) to taxes levied by the State of Kentucky on multichannel video programming services (the “2005 Amendments”).2 Enacted against the backdrop of the tremendous growth of the DBS industry and an increasingly complex system of local franchise fees applicable to cable television systems, the 2005 Amendments sought to impose a “fair, efficient, and uniform method of taxing communications services sold” in Kentucky and to simplify “an existing system that includes a myriad of levies, fees, and rates imposed at all levels of government.”3 The DBS Plaintiffs filed suit in federal court seeking to enjoin the taxes, alleging that they discriminated against DBS providers, and interstate commerce, in violation of the dormant Commerce Clause of Article I of the U.S. Constitution as they permitted cable operators to offset their franchise fee payments against the taxes. On appeal from the district court’s dismissal of the DBS Plaintiffs’ action, the court of appeals affirmed, holding that the 2005 Amendments were lawful in purpose and effect, and did not discriminate against interstate commerce. This ruling has added significance in that various other states, including Florida, Tennessee, Ohio, and North Carolina, also have enacted taxes applicable to DBS, and such taxes also have been challenged in court by DirecTV and EchoStar.
Although the Telecommunications Act of 1996 forbids localities from taxing or assessing franchise fees on DBS service providers, like those widely imposed on cable systems, the 1996 Act expressly reserves to states whatever powers they otherwise may have to tax DBS operations. Kentucky’s 2005 Amendments provided for a 3.0 percent sales excise tax and a 2.4 percent gross revenues tax on all multichannel video programming services, including DBS, cable, and wireless providers.4 At issue in this case, the 2005 Amendments also prohibited local governments from any longer imposing franchise fees or taxes on cable television systems, but provided localities with a proportional share of the new state tax revenues in place of their lost franchise fees.5 Conversely, localities that persisted in imposing franchise fees or other taxes on cable systems, in contravention of the Amendments, would not be entitled to a share of the state tax revenues, and cable operators forced to pay such illegal franchise fees would receive corresponding credits against the new state excise and gross revenues taxes.6
The DBS providers challenged those provisions of the 2005 Amendments that afforded cable operators relief from their prior franchise fees or, alternatively, a credit against the new state excise and gross revenues taxes. They alleged that, although the 2005 Amendments were not facially discriminatory because they applied to both DBS and cable, any tax credits or relief from franchise fees afforded to cable television operators by this statutory mechanism discriminated, in their practical effect, in favor of “intrastate” cable operators and against “interstate” DBS providers, “because revenues from the state excise and gross revenues tax are used to pay franchise fees that cable operators would otherwise have to pay local governments for access to local rights-of-way.” In the DBS Plaintiffs’ view, “[t]his discriminates against interstate commerce because cable companies, which provide service via infrastructure necessarily located within the state, get the tax preference while satellite companies, which provide service via satellites inherently located out of the state, get no tax preference.”
The court of appeals unequivocally rejected these arguments. The court noted initially that state and local governments “are under no mandate to charge for the use of local rights-of-way … [and that] States have wide latitude to ‘encourage the growth and development of intrastate commerce and industry.’” Interestingly, the court observed that the DBS Plaintiffs did not contend that the State of Kentucky could not have solely banned local governments from imposing franchise fees on cable companies, and that it did not appear to the court that doing so would have violated the Commerce Clause.
Addressing the heart of the DBS Plaintiffs’ claims, the 6th Circuit found that Kentucky “has not otherwise altered any competitive balance among in and out-of-state competitors” and has “simply prevented localities from mulcting cable companies through franchise fees.” Further, the 6th Circuit recognized that legitimate purposes underpin the 2005 Amendments, including “simplifying the labyrinthine system of fees cable companies currently face and collecting taxes from the previously untaxed, burgeoning satellite industry.” The fact that satellite companies would not benefit from the relief from franchise fees, because they do not use local rights-of-way, was of no moment to the court of appeals, as the Commerce Clause “does not protect the particular structure or methods of operation” chosen by a company to participate in a market. In the court’s view, the 2005 Amendments were not in the nature of a protective tariff whose only purpose is to benefit in-state interests at the expense of out-of-state interests, or the functional equivalent thereof, which it referred to as the “paradigmatic example” of a law that violates the dormant Commerce Clause. Finally, the court noted that even if a purpose of the 2005 Amendments had been to aid the cable industry rather than the satellite industry because the former has a larger in-state presence than the latter, “there were clearly many other purposes” that legitimately could have motivated the Kentucky legislature to enact the 2005 Amendments.
The DBS providers may now seek rehearing by the same panel of the 6th Circuit, rehearing en banc by the full court of appeals, or petition the United States Supreme Court to review the court of appeals’ decision.
The Kentucky Cable & Telecommunications Association, which filed briefs as amicus curiae in the district court and court of appeals, was represented by Cole, Raywid & Braverman, which merged with Davis Wright Tremaine in January 2007.
1 DirecTV, Inc. v. Comm’r for the Dep’t of Revenue for the State of Ky., No. 06-5523, slip op. (6th Cir. filed May 31, 2007).
2 See 2005 Ky. Acts 168, Ky. H.B. No. 272, 2005 Regular Session (2005) (the “2005 Amendments”) (codified at various sections of Chapter 136 of the Kentucky Revised Statutes).
3 KY. REV. STAT. § 136.600(1).
4 See KY. REV. STAT. §§ 136.604(2), 136.616(1), (2)(a).
5 See KY. REV. STAT. § 136.660.
6 See id.