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General Memorandum 14-014

General Memorandum 14-014
Federal District Court Upholds Federal Excise Tax on Tobacco Products Manufactured by Tribal Company on Tribal Lands

On January 24, 2014, the United States District Court for the Eastern District of Washington ruled for the United States in King Mountain Tobacco Company v. Alcohol and Tobacco Tax and Trade Bureau, a case challenging the application of the federal excise tax on tobacco products when manufactured on tribal lands by a tribally-chartered company, using some tobacco grown on tribal land. The court upheld the application of the tax to the products.

Plaintiff King Mountain Tobacco Company (King Mountain) is a corporation organized and operating under the laws of the Yakama Nation. It manufactures cigarettes and other tobacco products on the Yakama reservation, using tobacco that is a blend of tobacco grown on Yakama Nation trust land and elsewhere.

Federal law imposes an excise tax on the manufacturing of tobacco products. King Mountain argued that this tax does not apply to it for several reasons. The court ruled against the company on each basis.

First, the court held that the General Allotment Act (GAA) did not preclude the tax. The court reasoned that the GAA's restriction on taxation was limited to "the trust and income thereto" (quoting Squire v. Capoeman, 351 U.S. 1 (1956)). The court held that while income from unprocessed tobacco grown on trust land "could be deemed as derived directly from the land" and therefore exempt from the excise tax, an excise tax on manufacturing activity was not exempt. According to the court, manufacturing is a process that combines labor and capital investment, and is not a product derived directly from the land.

The court held that the proportion of trust land tobacco used in the tobacco products (ranging from 20 to 55 percent ) was therefore not determinative, since the tax was on the manufacturing process, and not on the tobacco. For much the same reason, the court declined to grant King Mountain an allocated tax exemption equal to the proportion of its finished product made from trust land tobacco.

The court also provided an alternative basis for its holding that the GAA did not preclude the tax—that King Mountain, the manufacturer, is not the allottee, and is therefore not subject to the GAA's preemption on taxation in any event.

Second, the court held that King Mountain is not exempt from the tax under Article II of the Yakama Treaty of 1855, which sets aside lands "for the exclusive use and benefit" of the Yakama Nation. The court held that under Ninth Circuit precedent, a federal tax will apply unless the Indian treaty can be shown to have "express preemptive language," a more difficult standard than employed in other courts, and also more difficult than the standard employed by the Ninth Circuit when it is argued that a treaty preempts a state tax. Finding no "express preemptive language" in the treaty, the court ruled against the company on this argument. Again, the court distinguished income derived from the land itself, which was set aside by the treaty, from income derived from an activity on the land.

Third, the court addressed King Mountain's argument that the tax was precluded by Article III of the Treaty of 1855, which granted Yakamas access to travel to and upon public highways. The court noted that the tobacco excise tax was not a tax upon the use of roads. The court distinguished its earlier decision in United States v. Smiskin, 487 F.3d 1260 (9th Cir. 2007), where the court had held that this treaty provision preempted, as to Yakama tribal members, Washington State's requirement that individuals give notice to state officials prior to transporting unstamped cigarettes within the State. The court held that because a federal excise tax is at issue, rather than a state tax, as in Smiskin, the "express preemptive language" standard applied, and so Smiskin—which was based on extrinsic evidence and not express language—was distinguishable.

Finally, the court rejected the argument that the products were exempt from taxation under Section 4225 of the Internal Revenue Code, exemption of articles manufactured or produced by Indians. That exemption did not apply, according to the court, because it was limited to excise taxes in one chapter of the Code, but the tobacco excise taxes were found in a different chapter of the Code.

Please let us know if we may provide additional information regarding this case.

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Inquiries may be directed to:
Michael Roy mroy@hobbsstraus.com

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