The Supreme Court appears ready to duck the question of whether states may tax production credit associations and other Farm Credit System lenders.

Banking trade groups have urged the justices to force these farm lenders to pay taxes, putting them on a more equal footing with private-sector financial institutions. But during arguments Monday, the justices appeared poised to send the case to a state court rather then decide it.

The case began in 1994 when Arkansas taxed Farm Credit Services of Central Arkansas, one of 60 production credit associations nationwide that provide short-term loans for seed and equipment.

Farm Credit Services challenged the tax in federal court, arguing that states may not tax instruments of the federal government. The federal appeals court in St. Louis concurred.

During arguments before the Supreme Court, both parties agreed that the Tax Injunction Act gives jurisdiction over state tax disputes to state courts.

The only exception is for cases involving federal "agencies," a broad term that includes any entity that acts on the government's behalf. The parties disagreed whether production credit associations qualify as government agencies.

0The President should decide if an entity qualifies as a federal agency by ordering the Justice Department either to intervene or stay out of these tax disputes, argued Martha Grissom Hunt, legal counsel to the Arkansas Revenue Department.

Because President Clinton did not order the Justice Department to intervene, production credit associations are not federal agencies, she told the justices. This means they are subject to state taxes and may bring legal challenges only in state court, she said.

Richard A. Hanson, representing Farm Credit Services, countered that federal judges should decide if entities qualify as agencies by looking at whether they fulfill congressional mandates.

Under this test, production credit associations qualify as federal agencies because they have a legal obligation to lend to farmers, he said.

Mr. Hanson, a partner at the Chicago law firm of McDermott, Will & Emery, also said that production credit associations are similar to Federal Reserve banks because both make credit available to members. The courts had previously ruled that reserve banks are exempt from state taxes, he noted.

Both sides were hammered by the court. Justice Antonin Scalia warned that Ms. Hunt's proposal would permit a vindictive President to deprive an agency of its right to sue in federal court to avoid state taxes.

Justice Stephen J. Breyer criticized Mr. Hanson's comparison of the Farm Credit System with the Fed, saying that the central bank regulates financial institutions and returns profits to the Treasury Department while production credit associations are farm lenders that give profits to their shareholders.

By the end of the hour-long argument Ms. Hunt appeared to prevail, because at least four of the nine justices suggested letting Arkansas courts decide the case. "What harm is there in saying ... go to the state courts?" Justice Sandra Day O'Connor asked. "You always have the right to petition this court if you think they have erred on the merits."

Sending the case to the state courts would be a mixed blessing for banks. On the plus side, production credit associations would have to pay state taxes while the case is pending. On the down side, any state court ruling would probably be appealed to the Supreme Court, so banks would have to bear the cost of another high-court showdown.

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