WASHINGTON - The U.S. Supreme Court on Tuesday heard arguments in a case challenging the tax-exempt status of banks chartered by the Farm Credit Administration to lend to agricultural cooperatives.

The case, Director of Revenue of Missouri v. CoBank ACB, appeals a state Supreme Court ruling that found CoBank is not subject to state corporate income tax because of its status under the Farm Credit Act as a "federal instrumentality."

Banking industry representatives, including the American Bankers Association, have argued that an exemption from state taxes reduces CoBank's operating expenses and gives it a competitive advantage over commercial competitors that must pay taxes.

CoBank, based in Denver, is the product of the merger of several cooperative banks, including the National Bank for Cooperatives, and is the only remaining Agricultural Credit bank in the Farm Credit System. The bank competes primarily with commercial banks to provide financing for agricultural cooperatives.

The arguments in the case are centered on the intent of Congress when it amended the Farm Credit Act in 1985. In doing so, it removed a tax exemption that had been granted to Agricultural Credit banks, but retained an exemption for "instrumentalities of the United States."

CoBank argues that under the 1985 amendment, it meets that description, and therefore cannot be taxed without the express permission of lawmakers. It claims that arguments to the contrary by its opponents are based on "abstract canons of construction" that require an unsupported interpretation of congressional intent.

Chicago attorney Richard A. Hanson, arguing on behalf of CoBank, said the 1985 amendment should be read as confirming the banks' tax-exempt status. He said that while the language of the statute may not be clear, "that fits with the overall goals of Congress in 1985."

Mr. Hanson faced close questioning from Associate Justices David H. Souter and Stephen G. Breyer, who both expressed doubts that the claim to be tax-exempt could stand without government investment in CoBank.

Arguing on behalf of the petitioner, Missouri State Solicitor James R. Layton claimed that the exemption the cooperative banks once enjoyed under federal law was overturned by Congress in 1985.

The original tax exemptions for cooperative banks, he said, were based on the fact that the U.S. government was a primary investor in the banks, making their income, in part, federal income. Government investment in Agricultural Credit banks ceased in 1968.

"Today there is no exception in the statutes, and the banks for cooperatives are responsible for paying taxes to state and local governments," Mr. Layton said.

Filings by lawyers for the state of Missouri, as well as friend-of-the-court briefs from the Solicitor General of the United States and the American Bankers Association, have argued that CoBank operates as a private enterprise, is therefore not truly an arm of the government, and should be subject to taxes.

According to the solicitor general's brief, "Congress has used the term 'instrumentality' in literally scores of enactments," many of which do not apply to tax-exempt entities. To make designation as a federal instrumentality the sole requirement for tax-exempt status, it warns, could have the unintended consequence of freeing dozens of enterprises from the obligation to pay taxes.

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