Bankruptcy Court Decision Lights Up the Priority Accorded to Excise Taxes

Contributed by Yvanna Custodio and Max Goodman
Int’l Tobacco Partners v. U.S. Dep’t of Agric. (In re Int’l Tobacco Partners), a recent decision from the United States Bankruptcy Court for the Eastern District of New York, sheds light on the scope of the priority status accorded to excise taxes under section 507(a)(8)(E)(ii), including what constitutes an “excise tax” and when an excise tax is considered to accrue for purposes of the priority provisions of the Bankruptcy Code.
The genesis of the dispute in International Tobacco Partners was a proof of claim filed by the U.S. Department of Agriculture (the “USDA”) against the debtor, an importer of discount and generic cigarettes and cigars.  The USDA asserted a priority tax claim for approximately $1.3 million of unpaid prepetition assessments due in accordance with 7 U.S.C. § 518d, a provision of the Fair and Equitable Tobacco Reform Act of 2004 (“FETRA”).  FETRA was enacted to transition U.S. tobacco farmers from a regulated to a free market system by redistributing to the tobacco farmers assessments levied on U.S. tobacco product manufacturers and importers.  Unlike most assessments, Congress fixed the total amount to be assessed under FETRA at $10.14 billion.  The USDA claim contained a schedule of quarterly assessments for each quarter beginning with the first quarter of fiscal year 2005 and ending a month prior to the debtor’s June 2010 petition date.
The debtor commenced an adversary proceeding against the USDA seeking declaratory relief, arguing that:  (i) the amounts owed were not taxes because the assessments imposed pursuant to FETRA lacked a public purpose; (ii) if the amounts were taxes, they should be deemed excise taxes under section 507(a)(8)(E), so amounts accruing more than three years before the petition date should not receive priority; (iii) any postpetition FETRA assessments (that the USDA may later claim) should not be allowed administrative treatment pursuant to section 503(b)(1), because the assessments do not benefit the estate and the assessments were fixed in 2005, the date FETRA became effective; and (iv) if, pursuant to section 507(a)(8), the assessments were excise taxes, then they were disqualified from administrative status pursuant to section 503(b)(1)(B)(i), which contains language excepting “a tax of a kind specified in section 507(a)(8) of this title.”
Judge Alan S. Trust devoted a number of pages to whether the assessments are excise taxes under federal law, observing that “tax” and “excise tax” are not defined in the Bankruptcy Code.  In particular, the court focused on whether the assessments effectuated a public purpose, a key element in distinguishing taxes from regulatory fees.  Recognizing that Congress “expressed a public benefit to unwinding the system of quotas and price controls” upon which U.S. tobacco farmers had become dependent, the court agreed with the USDA’s argument that the assessments furthered a public purpose and were correctly characterized as “excise taxes.”
Prepetition excise taxes for which returns are not required to be filed are entitled to priority under section 507(a)(8)(E)(ii) only if they relate to a transaction occurring during the three years before the petition date.  The debtor argued that no portion of the USDA claim should be accorded priority status because all the assessments accrued on the day FETRA became effective in 2005, as the total amount collectible became fixed on that date, which was more than three years prior to the petition date.  The USDA, on the other hand, argued that the excise taxes accrued upon the issuance of quarterly invoices to the debtor, which are based on “transactions” during the previous quarter.
The bankruptcy court rejected both the debtor’s and the USDA’s arguments.  Instead, the court observed that the language of the relevant statutes and regulations indicates that “liability attaches when a [t]obacco [m]anufacturer ‘removes’ its tobacco products and makes them available for marketing and sale in the United States.”  The court thus held that the portion of the assessments entitled to priority treatment corresponds to the tobacco products that were “released from customs in the ‘three years immediately preceding the date of the filing of the petition[.]’”
The debtor also argued that any postpetition assessments should not be given administrative treatment pursuant to section 503(b)(1)(A), because the assessments do not benefit the estate.  The court observed that section 503(b)(1)(B), which accords administrative status to “any tax . . . incurred by the estate . . . .” was the appropriate provision under which to analyze the assessments and, therefore, it was unnecessary to address whether the assessments were incurred as part of “the actual, necessary costs and expenses of preserving the estate” under section 503(b)(1)(A).
Finally, based on its reading of section 503(b)(1)(B)(i), which excludes taxes “of a kind specified in section 507(a)(8),” the debtor presented a novel argument that, if a kind of tax is entitled to priority under section 507(a)(8)(E), it is excluded from administrative status.  The court rejected the debtor’s “either-or approach” and noted that the language disqualifying from administrative status taxes accorded priority under section 507(a)(8) applies only to taxes that accrue prior to the petition date.  Consequently, excise taxes accruing postpetition do not, as a matter of course, fall under section 507(a)(8)(E)(ii).
Ultimately, the court rejected the debtor’s attempt to smoke out the USDA’s claims.  The court ruled that the FETRA assessments that had accrued within the three years prior to the petition date were entitled to priority tax status, those that had accrued before the three years prior to the petition date were general unsecured claims and, although the USDA had not yet filed a proof of claim for postpetition FETRA assessments, the court also ruled that any such assessments accruing postpetition would be entitled to administrative expense status.
International Tobacco Partners thus illustrates (i) the seemingly broad scope of what constitutes a tax under federal law, (ii) the expansive judicial interpretation of public purpose when courts rule on whether assessments are properly characterized as taxes, and (iii) how bankruptcy courts determine when an excise tax accrues.  The decision also highlights that the accrual date of a tax dictates whether the tax should be treated as a general unsecured claim, a priority unsecured claim, or an administrative expense claim.  Moreover, applying the priority rules to bankruptcy tax claims requires a straightforward analysis of the Bankruptcy Code and, as demonstrated in International Tobacco Partners, bankruptcy courts are reluctant to accept attempts to limit priority through strained readings of the Bankruptcy Code.