Ohio high court may be next stop for bondholder's suit over state tax.

CHICAGO -- A lawsuit involving Ohio's taxation of income on out-of-state municipal bonds will be appealed to the Ohio Supreme Court now that the state appellate court has upheld a lower court decision sanctioning the practice.

Clint Krislov, a Chicago attorney representing the Ohio bondholder who filed the suit, said the state's high court will be petitioned later this month to hear the case. If that court declines, he said, the case will then be taken to the U.S. Supreme Court.

The Ohio Appeals Court on Sept. 29 affirmed a November 1993 decision by a Franklin County Common Pleas Court judge, who rejected the suit's contention that the state's taxation of the bond income violated the commerce clause of the U.S. Constitution. The judge ruled that the commerce clause "was never intended to govern transactions between government entities."

The lawsuit against the Ohio revenue department was filed in 1992 by Serene G. Shaper, a bondholder who lives in a suburb of Cleveland. The suit charges that "the imposition of state income tax upon interest paid by non-Ohio governmental entities is an unreasonable burden on interstate commerce and is nothing more than a protectionist measure that cannot withstand scrutiny under the commerce clause."

In its affirmation, the appellate court differed with the lower court on whether or not the state of Ohio acts as a market participant -- a key determination under the commerce clause. The lower court found that the state is a market participant and, as such, its taxation of income on out-of-state bonds is constitutional because the commerce clause is only directed at its action as a market regulator.

However, the appellate court held that the state is not a market participant, but a market regulator "in its assessment of taxes," according to the opinion. Still, the court agreed with the lower court's ruling in the case, pointing out the lack of case law support for applying the commerce clause to a similar situation.

Krislov said the appellate court's interpretation of the state's market participant role puts the issue of "whether the commerce clause applies to a state acting in its own self-interest squarely before the next court."

But, Lawrence Pratt, a state assistant attorney general, called the discrepancy a difference in theory that still led the appellate court to rule that the state's taxing practice is constitutional.

Pratt said the appellate court also declined the bondholder's request to certify the lawsuit as a class action. He said the court agreed with the state that individuals should petition the state's tax commission for a tax refund.

The lawsuit has caught the attention of municipal bond industry participants, who have said the case could have a major impact on the industry if it is ultimately successful. For example, specialty state mutual funds could lose the advantage of double tax exemption and governments could lose income tax revenues collected on out-of-state bonds.

Currently, 42 states, including Ohio, collect income taxes on out-of-state bonds, while exempting all or some of their own bonds from taxation.

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