Information Systems & Networks Corporation

On Petition for Writ of Certiorari to the United States
Court of Appeals for the Federal Circuit.

1. Does the decision below denying petitioner the right to be reimbursed for the state income taxes it paid as a result of performing its contract with the government subvert the purposes of the Federal Acquisition Regulations, the Small Business Act, public policy and Congress' intent that government not penalize through its reimbursement scheme those who elect to organize themselves as a Subchapter S corporation ?

2. Does the decision below run afoul of the policies of Congress and the Executive Branch which foster the robust participation of small businesses generally and Subchapter S corporations in particular in the Nation's commerce, including the federal government's procurement of goods and services from vendors such as the petitioner?

3. Is the constitutional guaranty of the equal protection of the laws undermined by the decision below which applies the Federal Acquisition Regulation s differently for no reason rooted in law to those like the petitioner who as a small business elects to organize itself as a Subchapter S corporation?

Questions Presented For Review..................................................................................................... i

Table of Contents............................................................................................................................ii

Table of Authorities.........................................................................................................................iii

Citations of Opinions and Orders.....................................................................................................

Basis for Jurisdiction in this Court.....................................................................................................

Constitutional and Statutory Provisions Involved...............................................................................

Statement of the Case......................................................................................................................

Argument Supporting Allowance of the Writ.....................................................................................

Conclusion....................................................................................................................................

Appendix.................................................................................................................................. post

The published opinion of the United States Court of Appeals for the Federal Circuit in Information Systems & Networks Corporation v. United States (C.A. Nos. 04-5151 and 5154), 437 F.3d 1173, U.S. App. LEXIS 2820 (Fed. Cir. 2006), decided February 6, 2006, reversing the United States Court of Federal Claims which allowed the petitioner to recover as part of its costs under its reimbursement contract with the respondent United States the state income tax payments its sole shareholder paid as part of the business activities related to this contract, is set forth in the Appendix hereto(App. 1-10).

The published opinion of the United States Court of Federal Claims in Information Systems & Networks Corporation v. United States (Docket No. 98-663C), 48 Fed. Cl. 265 (2000), decided November 30, 2000, allowing the petitioner to recover as part of its costs under its reimbursement contract with the respondent United States the state income tax payments its sole shareholder paid as part of the business activities related to this contract, is set forth in the Appendix hereto (App. 11-30).

The unpublished order of the United States Court of Appeals for the Federal Circuit in Information Systems & Networks Corporation v. United States (C.A. Nos. 04-5151 and 04-5154), decided and filed April 14, 2006, denying the petitioner's timely filed combined petition for panel rehearing or for rehearing en banc, is set forth in the Appendix hereto (App. 31-32).

The decision of the United States Court of Appeals for the Federal Circuit reversing the Court of Federal Claims' decision allowing the petitioner to recover its state tax payments as part of the reimbursable costs under this contract with the United States, was entered on February 6, 2006; its further order denying the petitioner's timely filed combined petition for panel rehearing or for rehearing en banc was filed and decided on April 14, 2006; on July 3, 2006, the petitioner timely applied to The Chief Justice of this Court for an extension of time to file its petition for certiorari (Docket No. 06A25); and on July 11, 2006, The Chief Justice granted the petitioner's motion, extending the time to file its petition for certiorari until August 14, 2006 (App.1;31).

This petition for writ of certiorari is filed within the time limits prescribed by the Chief Justice in Docket No. 06A25, allowing the petitioner's application for an extension of time to file this petition.

The jurisdiction of this Court is invoked pursuant to the provisions of 28 U.S.C. Section 1254(1).

Constitutional, Statutory and Rule Provisions
Implicated by This Petition.

The petitioner Information Systems & Networks Corporation ( “the petitioner” or “ISN”) is a corporation duly organized under Subchapter S of the Internal Revenue Code, 26 U.S.C. Sections 1361-1379. Such so-called “S corporations” are small businesses in corporate form which have fewer than 75 employees, 26 U.S.C. Section 1361(b)(1)(A), and often have a sole shareholder. In fact, during the years 1985 through 2000, INS' sole shareholder was Ms. Roma Malkani.

In electing to proceed in business as an S corporation, INS was taking advantage of the “tax neutral” provisions which attend such corporate status. As Congress provided, when a small business such as INS decided to incorporate as an S corporation, it incurred the same tax liability on its income whether the business incorporated or not. Subchapter S accomplishes this by eliminating the “double taxation” that usually attends corporate income from a normal or “C” corporation . See 26 U.S.C. Section 1363. With “C” corporations, the corporate entity must pay income taxes on its own income and then when it distributes after-tax income to its shareholders, those shareholders must also pay personal income tax on that source of income, a “double taxation.”

With S corporations, however, Congress has provided that no income tax accrues to the corporation; instead, the corporation's income is “passed through” to the shareholders and is attributed to the shareholders' personal income tax liability in pro rata amounts. 26 U.S.C. Section 1366. Most States have taken advantage of the option of recognizing the federal S designation by aligning their own tax codes with the federal Internal Revenue Code in order to acknowledge and allow this “pass through” of income tax liability from the corporation to the shareholder(s), taxing only the shareholder(s) for their personal income tax liability in pro rata amounts.

In the 1980's and early 1990's, the petitioner and the respondent United States (“the respondent” or “the government”) entered into several cost-reimbursement contracts. As explained in 48 CFR Section 16.301-1, where the cost cannot readily be ascertained at the time of contracting, these types of contracts between the federal government and a private contractor provide a cost ceiling for the work to be performed and permit the government to pay up to that ceiling amount for allowable incurred costs of the contractor for the contract work.48 CFR Section 16.301-2.

During its performance of a cost-reimbursement contract, the contractor incurs direct costs in the form of material, labor, equipment, etc. and indirect costs such as taxes, rental space, insurance, etc. Generally, both direct and indirect costs generated by the contract's performance are allowable if they are reasonable, allocable to the contractor's performance of the contract, founded on generally accepted accounting principles, within the terms of the contract and not otherwise prohibited. 48 CFR Section 31.201-1 and 2. Once performance is complete, a contractor is paid for its indirect costs by requesting reimbursement for them via an “indirect rate proposal.” The proposal requests that these costs be included in a so-called “rate pool.” The government audits the proposals, determining whether the costs stated by the contractor are allowable within the terms of 48 CFR Section 31.201-1 and 2, and ultimately pays the contractor for its allowable costs according to the rates established by the contract.

The dispute giving rise to this controversy began when the petitioner submitted indirect rate proposals for FYs 1985 through 1991, proposals which included a request for reimbursement of state income taxes paid for each of those years within its general and administrative expense rate pool. In support of its request for reimbursement of the state taxes it had paid, INS asserted that the Federal Acquisition Regulations, especially 48 CFR Section 31.205-41(a)(1), intended to include such tax reimbursement within its framework; that there was a valid, binding agreement between INS and its sole shareholder, Ms. Malkani, which obligated INS to reimburse her for the state income taxes she paid (to the State of Maryland) as a result of the “pass through” nature of the income earned by this S corporation, thereby creating a valid, reasonable cost to INS in the performance of its contract with the government; and that other S corporations had been reimbursed for state income taxes in this manner.

All of the state income taxes for which the petitioner has sought reimbursement from the government were imposed in States which acknowledge and allow this “pass through” of income tax liability from the corporation to the shareholder(s), taxing only the shareholder(s) for their personal income tax liability in pro rata amounts, as under the Internal Revenue Code. The petitioner subsequently submitted rate proposals, including requests for state income tax payments, for each fiscal year up to and including 2000.

Except for one year, the government's audit agency (the Defense Contract Audit Agency or “DCAA”), which processed the petitioner's proposals, denied INS' claims for reimbursement of the state income taxes it paid for these years as unallowable. DCAA based its decision on the fact that INS was an S corporation and therefore was not subject to state income tax:

This dispute continued until April 16, 1998, when the government's Contracting Officer denied INS' claims for the reimbursement of the state income taxes it paid and ordered the petitioner to repay the government for earlier reimbursements it deemed unallowable costs.

On August 18, 1998, the petitioner appealed the Contracting Officer's decision to the United States Court of Federal Claims pursuant to the provisions of the Contract Disputes Act of 1978, 41 U.S.C. Section 609(a)(1). It asked the court to declare that when Ms. Malkani paid state income taxes on its behalf as the sole shareholder of this S corporation, it was a reimbursable, allowable cost under the Federal Acquisition Regulations and therefore should have been included in its indirect rate cost pool for all the contracts performed by the petitioner for the government. The government counterclaimed asking for the return of its previous reimbursements of a portion of the state income taxes paid by INS.

Upon cross motions for summary judgment, the Court of Federal Claims, Futey, J., first reviewed all of the pertinent provisions of the Federal Acquisition Regulations, especially 48 CFR Section 31.205-41, addressing whether the payment of taxes could be allowable costs entitled to reimbursement in this context (App. 18-19). As the motion judge concluded, those provisions of the Federal Acquisition Regulations specifically addressing how the payment of taxes should be considered for purpose of determining whether such tax payments are “costs” to be reimbursed unmistakably provide that certain Federal, state and local taxes are allowable if they are “are required to be and are paid or accrued in accordance with generally accepted accounting principle” but that if the contractor “is exempt from a certain tax liability...and still proceeds to pay such tax, that tax expenditure is not allowable”(App. 19 citing 48 CFR Section 31.205-41(a) and (b)(3)).

The petitioner argued that Subpart 31.2 of the Federal Acquisition Regulations by its own terms applies to all “commercial organizations,” including Subchapter S Corporations, and there are no provisions justifying different treatment of this entity in determining whether state taxes are allowable costs(App. 19). Moreover, it contended that Ms. Malkani had to pay the state a personal income tax as a result of this corporate income; that it was required by agreement to reimburse Ms. Malkani, its sole shareholder, for this expense; and that such expense was reasonable and allocable because “it was necessary to maintain its [corporate] charter [in the State] and therefore its ability to continue performing work on its contracts with the government”(App. 19-20). The government argued that since INS did not have to pay state income tax in the first instance, its claims for reimbursement are neither allowable under 48 CFR Section 31.205-41(a) and (b)(3), nor reasonable or allocable under the general provisions regulating reimbursement (App. 20).

Judge Futey, however, reasoned that the petitioner's payment of State taxes even though made in the form of reimbursing Ms. Malkani for the State personal income tax she was compelled to pay on account of this corporate income, was an allowable and therefore reimbursable cost. As he saw it, although INS is technically “exempt” from paying state income taxes on its corporate income because of its S corporation status, it is not an exemption in the ordinary sense of that term, i.e., the complete absence of a duty to pay taxes such as when a tax abatement occurs (App. 21-22;28-29). Instead, the petitioner is relieved of paying State income tax only because its duty to do so has not been extinguished but merely transferred to another entity, its sole shareholder Ms. Malkani, as a result of the “pass through” provisions which characterizes this corporate form as mandated by Congress(App. 21-22). Thus the motion judge concluded that the petitioner, “as an S corporation, is not relieved of state tax liability, but is simply required to pass its liability on its corporate income to Ms. Malkani”(App. 22).

As the motion judge concluded, nothing in the Federal Acquisition Regulations requires that any specific part of a corporation pay the applicable State income taxes (App. 22). Instead, it clearly provides that State taxes which are required to be paid and are paid constitute allowable costs; and because the State taxes here were required to be paid and were paid and “because the tax liability on the corporate income was not subject to abatement or reduction, the state income taxes claimed by the [petitioner] for reimbursement are allowed under the Taxes Provision [of the Federal Acquisition Regulations]”(App. 22).

In a footnote, Judge Futey reasoned that the language forbidding reimbursement when the contractor is “exempt” from the state tax was intended to avoid a “double recovery” by a contractor who is reimbursed by the government for taxes it erroneously paid but does not owe and thereafter receives a refund of the tax from the taxing authorities resulting in a double recovery (App. 29). However, as he noted, there is no danger of a double recovery here because “no refund is available from the state tax authority...[and] the taxes were not erroneously or mistakenly paid but were in fact required to be paid”(App. 29).

In addition, the lower court thought that its interpretation of the Federal Acquisition Regulations to find that the taxes here were allowable costs comports with their general intent not to deny reimbursement to business entities simply because of their tax election or corporate structure (App. 22). Nor does any language in the Internal Revenue Code support the proposition that an election to do business as a Subchapter S corporation with the characteristic of pass-through taxation will cause it to lose out on reimbursement due to its tax election (App. 22). As it observed, neither the Federal Acquisition Regulations nor Subchapter S of the Internal Revenue Code state that an S corporation is only allowed one type of tax relief, either pass-through taxation or cost-reimbursement (App. 22). As it noted,

S corporations are small businesses and their corporate
structure is meant to help, not hinder, the growth and health
of these businesses. It is the general intent of the [Federal
Acquisition Regulations] to aid and encourage small
businesses as well. [Moreover,] if the Taxes Provision does
not allow reimbursement for state income taxes for S
corporations, such corporations will most likely change
their tax election to C corporation status in order to
benefit from the cost reimbursement available from the
Taxes Provision. This change in election would cause
these government contractors to be taxed at the higher
C corporation rates, and therefore the amount the federal
government will be required to reimburse will be higher
as a result.

(App. 12;29-30). Especially where the S corporation has reimbursed its sole shareholder for the state tax payments which it incurred and which she made on its behalf and where other S corporations previously have been reimbursed for such payments, the government “is obligated to reimburse [ISN] for this transferred pass-through tax expenditure”(App. 23).

Finally, Judge Futey rejected the idea propounded by the government that the two tax liabilities associated with an S corporation's pass-through income are separate and distinct and that ISN has no basis for requesting reimbursement for the tax expenditures of Ms. Malkani (App. 23-25). His review of the tax codes of the relevant States showed that the relationship between an S corporation and its shareholders is an intermingled, intertwined one for state tax purposes, i.e., both the S corporation and its shareholders are “very much” obligated to ensure that state income taxes generated by corporate business are paid (App. 25).

The lower court therefore granted the petitioner's motion for summary judgment, denied the government's cross motion for the same relief and ruled as a matter of law that the Taxes Provision of the Federal Acquisition Regulations (48 CFR Section 31.205-41) allows an S corporation to be reimbursed for the costs associated with the payment of state income tax taxes incurred on its corporate income in the course of performing its cost-reimbursement contract with the government (App. 25). In a ruling of July 21, 2004, Judge Futey determined after a trial that the petitioner was entitled to reimbursement from the government for the applicable years between 1985 and 2000 in the amount of $1,133,176.00.

The government appealed summary judgment ruling to the court of appeals for the federal circuit and on February 6, 2006, the court, in an opinion by Frost, J., reversed Judge Futey, ruling that he had improperly interpreted the Taxes Provision of the Federal Acquisition Regulations, 48 CFR Section 31.205-41(App. 1-10). According to the court of appeals, while the language of the Taxes Provision makes clear that the term “exemption” means freedom from taxation in whole or in part and may include a tax abatement or reduction, there is no support in the Federal Acquisition Regulations for the conclusion that tax abatements or reductions represent the exhaustive list of exempt taxes (App. 7).

In addition, the court appeals ruled that Judge Futey had erred by supposing that since state income taxes were required to be paid and were paid here, that allowability of this cost inevitably follows under the Federal Acquisition Regulations (App. 7-8). As it ruled,

Because the Court of Federal Claims had improperly interpreted 48 CFR 31.205-41(b)'s language about “exemptions” too narrowly and had improperly concluded that Ms. Malkani's state income tax payments ere allowable costs, it reversed the ruling below and remanded the case to that court for further proceedings consistent with that opinion (App. 9-10).

On April 14, 2006, the court of appeals denied the petitioner's timely filed combined petition for panel rehearing or for rehearing en banc (App. 31-32). On July 11, 2006, The Chief Justice granted the petitioner's timely filed motion seeking an extension of time to file its petition for certiorari until August 14, 2006.

1. Denying A Subchapter S Corporation Recovery As Part Of Its Allowable Costs Under Its Reimbursement Contract With The Respondent The Income Taxes Its Sole Shareholder Paid To The State Undermines The Purposes Of The Federal Acquisition Regulations, the Small Business Act, Public Policy and Congress' Intent That The Federal Government Not Use The Reimbursement Scheme To Penalize Those Who Organize Themselves In Business As A Subchapter S Corporation.

The gist of the court of appeals' ruling below is that even though there was an agreement in place between ISN and its sole shareholder, Ms. Malkani, for ISN to reimburse her for any state income tax she was compelled to pay as the result of ISN's corporate income “passed through” to her on account of its Subchapter S status, it was nevertheless a tax liability founded upon Ms. Malkani's “income derived from ISN's corporate dividends.” (App. 7-8)(emphasis supplied). As such, it was a tax liability separate and distinct from ISN which was the contracting party with the government and which is exempt or free from taxation (App.7-9). Thus the court of appeals ruled without citation to any decisional law that Ms. Malkani's state income tax payments themselves cannot be an allowable cost for ISN (App. 9).

This ruling misapprehends the true nature of S corporations as contemplated by Congress when it authorized in the Internal Revenue Code these hybrid corporate structures for use by small businesses in order to avoid the “double taxation” incident to the formation of traditional C corporations. It also misconstrues relevant portions of the Federal Acquisition Regulations in a way that makes every S corporation “exempt” from paying taxes and therefore ineligible for reimbursement for the taxes it actually does pay as a cost of doing business under the government's procurement programs.

More important, this result by the court of appeals undercuts completely Congress' expressed intent in establishing Subchapter S status in the Internal Revenue Code and enacting the Small Business Act (16 U.S.C. Section 631 et seq.) of encouraging small businesses such as INS to engage robustly in the Nation's commerce, including the federal government's procurement of goods and services , on the same footing as traditional C corporations. In fact, the court of appeals' decision serves as a rationale to penalize those who organize themselves in business as an S corporation by denying them reimbursement for the state taxes they do pay as a cost of doing business with the government, thereby encouraging these entities to reform themselves as traditional C corporations who will eventually seek and obtain even larger reimbursements from the government for the state taxes they pay incident to their cost-reimbursement contracts.

In the first place, in establishing S corporation status in the Internal Revenue Code, Congress provided that while the S corporation itself would not be subject to taxes “imposed by this chapter,” corporate income for tax purposes would “pass thru” or be transferred to the corporation's shareholder(s) on a pro rata basis. 26 U.S.C. Sections 1363(a); 1366(a)(1). As Congress provided,

That is, the S corporation organizational form serves as a conduit for the taxable income of the corporation to flow from the corporate level to the shareholder(s) for purposes of reporting this corporate income on the shareholder's personal income tax return. In this way, the corporation's income and expenses are “passed through” and taxed to the shareholder(s) at the corporation's year end, regardless of whether the shareholder(s) ever actually receive this corporate income. 26 U.S.C. Sections 1367(a);1368. The essence of the arrangement is the transfer of the S corporation's tax liability on its income to the corporation's shareholders on a pro rata basis.

After all, Congress was acknowledging the fact that a small business' decision to incorporate under Subchapter S of the Internal Revenue Code, i.e., to carry on its business in corporate form but without invoking the “double taxation” applied to traditional C corporations, was bottomed on its desire to do business like a partnership but in corporate form without incurring unnecessary tax penalties. See Klein v. Comm., 75 TC 298, 302-303(1980). Indeed, when Congress enacted The Subchapter S Revision Act of 1982, it intended to minimize further the effect of income taxes on the decision to form a business organization by continuing to enable small businesses to have the benefits of incorporation as an S corporation without the incidence of income at both the corporate and shareholder level. See S. Rep. No. 640, 97 th Cong., 2d Sess. 5, reprinted in 1982 U.S. Cong. & Adm. N. 3253-57.

Judge Futey appreciated this unique taxation scheme by finding that the relationship between an S corporation and its shareholder(s) for tax purposes could not be characterized simply as separate and distinct but rather was a hybrid one which was intermingled and intertwined, i.e., whether a shareholder pays state income tax on corporate income with the corporation reimbursing her or whether the S corporation itself pays the income tax directly to the state, the S corporation---- not the shareholder----is subject to potential penalty and/or encumbrance of its ability to do business within that state in the event this tax is not paid by either the corporation or the shareholder.

As the Court of Federal Claims explained, in order to enforce the payment of state income taxes owed by nonresident shareholders, many states require the S corporation itself to pay such taxes on behalf of the shareholder(s) either in the form of a corporate-level tax or in the form of a withholding tax. See, e.g., Idaho Code, Section 63.3022(k); La. Rev. Stat. Ann., Section 47:287.732; Okla. Stat., Section 2365; Utah Code Ann., Section 59-7-105(3)(c); Vt. Stat. Ann., Sections 5811 (18), 5823(a); W.Va. Code, Section 11-21-71a(b), (h); Wis. Stat., Sections 71.33, 71.36. These statutorily mandated requirements for an S corporation to conduct business in a particular State confirm Judge Futey's analysis that the S corporation's state tax obligation begins with the S corporation itself and is thereafter intermingled and intertwined with its shareholder(s).

It is not simply the shareholder's obligation alone to pay the S corporations's state taxes and the court of appeals was wrong to conclude otherwise. Once the true dimensions of the “pass through” nature of the S corporation's income tax liability are acknowledged and ISN's inability to conduct business in a state if its taxes are not paid are recognized, as the Court of Federal Claims did here, it becomes clear that Ms. Malkani's payment of the state tax payments—coupled with ISN's agreement to reimburse her for those state tax payments—are reasonable, allocable and therefore allowable within the meaning of 48 CFR Sections 31.201-2 et seq.

Second, the decision of the court of appeals ignores the plain language of the Federal Acquisition Regulations in a way that makes every S corporation “exempt” from paying taxes and therefore ineligible for reimbursement for the taxes it actually does pay as a cost of doing business under the government's procurement programs. As an initial matter, there is absolutely no support on this record for the court of appeals' surmise that Ms. Malkani was somehow receiving corporate dividends for which she was paying state income taxes (App. 7-8;9). Instead, ISN's corporate income was being transferred and therefore attributed to Ms. Malkani via the “pass through” provisions of 26 U.S.C. Sections 1366(a) and (b), as mandated by Congress. This revenue generated by ISN under its cost-reimbursement contract with the government is not a dividend and the court of appeals' decision to characterize it as such bespeaks a confusion on its part about the true nature of this arrangement for tax purposes and undermines the decision it reached in this matter.

Nor did the court of appeals apply the appropriate standard for construing the term “exemption” in 48 CFR Section 31.205-41(b)(3), to include the “pass through” tax payment arrangement here between ISN and its sole shareholder Ms. Malkani. Just because ISN can “pass through” its income to its sole shareholder Ms. Malkani for income tax purposes under the Internal Revenue Code does not mean that it is “free from taxation” in the sense that it is “exempt” from tax liability within the meaning of 48 CFR 31.205-41(b)(3). As Judge Futey cogently observed, as an S corporation, ISN “is not relieved of state tax liability [by this arrangement], but is simply required to pass its liability on its corporate income to Ms. Malkani”(App. 22).

This construction of 48 CFR Section 31.205-41(b)(3) by Judge Futey which makes ISN's claim for reimbursement of its state income tax payments allowable under the Federal Acquisition Regulations is correct as a matter of law. The starting point for this regulatory interpretation is the language of the regulations themselves. Duncan v. Walker, 533 U.S. 167, 172 (2001). Williams v. Taylor, 529 U.S. 420, 431 (2000). When that regulatory language speaks with clarity, “judicial inquiry into the [regulation's] meaning, in all but the most extraordinary circumstances, is ended.” Estate of Cowart v. Nicklos Drilling Co., 505 U.S. 469, 475 (1992). See Robinson v. Shell Oil Co., 519 U.S. 337 , 340 (1997); Walters v. Metropolitan Ed. Enterprises, Inc., 519 U.S. 202, 209 (1997).

Moreover, where the plain meaning of a tax regulation cannot be ascertained with sufficient certainty, “the doubt must be resolved against the government and in favor of the taxpayer.” United States v. Merriam, 263 U.S. 179, 188 (1923)(emphasis supplied). See also Hassett v. Welch, 303 U.S. 314 (1938). This rule of statutory construction is complemented by the principle that remedial regulations such as 48 CFR Section 31.205-41(b)(3), should be interpreted broadly in order to effectuate obvious Congressional goals. Northeast Marine Terminal Co. v. Caputo, 432 U.S. 249, 268 (1977). The resulting interpretation should be one consistent with the taxing statutes viewed as an organic whole. Brown v. Gardner, 513 U.S. 115, 118 (1994).

Applying these principles of construction, the term “exemption” in 48 CFR Section 31.205-41(b)(3), is strictly construed. Vill. of Shaumburg v. Citizens for a Better Env't., 444 U.S. 620, 644 n. 2 (1980). According to 48 CFR Section 31.205-41(b)(3), it means “freedom from taxation in whole or in part and includes a tax abatement or reduction resulting from mode of assessment, method of calculation, or otherwise.” However, as Judge Futey found, there was no such “exemption” here.

He found that although INS is technically “exempt” from paying state income taxes on its corporate income because of its S corporation status, it is not an exemption in the ordinary sense of that term, i.e., the complete absence of a duty to pay taxes such as when a tax abatement occurs (App. 21-22;28-29). Instead, applying this Court's decisional law that it will look to substance over form in a tax transaction, Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978), Judge Futey ruled that INS was relieved of paying state income taxes only because its duty to do so had not been extinguished but merely transferred to another entity, its sole shareholder Ms. Malkani, as a result of the “pass through” provisions which characterize this corporate form of small business, as mandated by Congress (App. 21-22). Thus he concluded that INS, “as an S corporation, is not relieved of state tax liability, but is simply required to pass its liability on its corporate income to Ms. Malkani”(App. 22).

As the motion judge ruled, nothing in the Federal Acquisition Regulations requires that any specific part of a corporation pay the applicable state income taxes (App. 22). Instead, it provides that state income taxes which are required to be paid and are paid constitute allowable costs; and because the state taxes here were required to be paid and were paid and “because the tax liability on the corporate income was not subject to abatement or reduction, the state income taxes claimed by the [petitioner] for reimbursement are allowed under the Taxes Provision [of the Federal Acquisition Regulations]”(App. 22). Judge Futey further reasoned that the language forbidding reimbursement when the contractor is “exempt” from the state tax was intended to avoid a “double recovery” by a contractor who is reimbursed by the government for taxes it erroneously paid but does not owe and thereafter receives a refund of the tax from the taxing authorities resulting in a double recovery (App. 29). However, as he noted, there is no danger of a double recovery here because “no refund is available from the state tax authority...[and] the taxes were not erroneously or mistakenly paid but were in fact required to be paid”(App. 29).

Third, the result below undercuts Congress' expressed intent in enacting the Small Business Act, 16 U.S.C. Section 631 et seq. The Act encourages small businesses such as INS to engage robustly in the Nation's commerce, including the federal government's procurement of goods and services, on the same footing as traditional C corporations. As Congress found incident to the Act's passage, it was intended to foster “business ownership and development by individuals in groups that own and control little productive capital...”15 U.S.C. Section 631(d)(2)(B)(I). In addition, Congress has declared that

15 U.S.C. Section 631a(a). None of these interests is served by affirming the court of appeals' reasoning below.

2. As A Matter Of Equal Protection Of The Laws, This Court Should Rule That The Petitioner, A Subchapter S Corporation, Should Be Allowed Like Any C Corporation
To Recover From The Respondent United States As Part Of Its Allowable Costs
Under Its Reimbursement Contract The State Income Taxes It Paid.

There is no question on this record that a C corporation would be entitled to reimbursement from the government for the state taxes it paid incident to its performance of a cost-reimbursement contract. That a Subchapter S corporation receives lesser treatment, that pursuant to the decision below it is not entitled to reimbursement for the state taxes it paid, amounts to the kind of disparate, unfair and unequal treatment which bespeaks a denial of the equal protection of the laws under the fifth amendment to the Federal Constitution. Allegheny Pittsburgh Coal v. Webster County , 488 U.S. 336, 343-344 (1989). Kahn v. Shevin, 416 U.S. 351, 355 (1974). Johnson v. Robison, 415 U.S. 361, 374-375 (1974). See Regan v. Taxation with Representation of Wash., 461 U.S. 540, 547 (1983); Carmichael v. Southern Coal Co., 301 U.S. 495, 509-510 (1937).

While ISN does not face the prospect of double taxation, it nevertheless faces the severely adverse consequence that its state tax liability will be unreimbursed by the government as a result of its election to organize itself as an S corporation. It therefore will have a higher cost of doing business than that of a C corporation in the same circumstances on account of its unallowable, unreimbursed state tax payments. This result, different from that of a C corporation in similar circumstances, is bottomed on no rule of law and constitutes a denial of the equal protection of the laws under the fifth amendment.

As a matter of the equal protection of the laws, then, this Court should rule that the petitioner, a Subchapter S corporation, should be allowed like any C corporation to recover from the government as part of its allowable costs under its cost-reimbursement contract the state income taxes it paid as a cost of doing business with the government.

For all of these reasons identified herein, a writ of certiorari should issue to review the judgment of the United States Court of Appeals for the Federal Circuit and, ultimately, to vacate that judgment and remand the matter to the United States Court of Federal Claims with instructions that it reinstate its decision allowing the petitioner to recover as part of its costs under its reimbursement contract with the respondent United States the state income tax payments its sole shareholder paid as part of the business activities related to the contract; or provide the petitioner with such other relief as is fair and just in the circumstances of this case.