Judge Holds Virgin Islands Use Tax Unconstitutional

August 22, 2007

Last month, a federal trial judge held that the 4 percent use tax in the U.S. Virgin Islands violates the Commerce Clause of the U.S. Constitution. The case, Molloy v. Government of the Virgin Islands, was brought by Robert Molloy, who moved from Virginia to the Islands and was forced to pay $2,365 in use taxes for property he brought from the mainland.

There is no sales tax in the U.S. Virgin Islands, but there is a 4 percent tax on all property brought into the territory from the mainland for personal use. These "use taxes" exist in most states and are levied on the use, storage, or other consumption within the state of goods or services purchased out of state. They usually accompany sales taxes ("sales and use tax"), and besides some high-ticket items, they are generally unenforceable.

Back in 1937, the Supreme Court upheld the constitutionality of use taxes in Henneford v. Silas Mason Co., so long as they were nondiscriminatory and "compensating"—that is, designed to equalize taxes on both locally produced and imported goods. In that case, the State of Washington imposed a 2 percent use tax on the use of personal property in the state, but reduced the tax by any sales tax paid to Washington or any other state. For instance, if I buy a painting in Virginia (5% rate) and use it in an office in D.C. (5.75% rate), D.C. will only tax the difference (0.75% rate).

This is where the Virgin Islands use tax erred. Locally produced goods were tax-free, while imported goods were subject to the tax. Presumably, Molloy's property had already been subject to sales tax somewhere else, but he still had to pay the full tax to the Virgin Islands government. As the judge put it:

The tax favors local businesses by sparing their merchandise sold within the territory and interferes with the free flow of goods across territorial boundaries. The legislature of the Virgin Islands, in enacting this tax, was engaging in prohibited economic protectionism.

Molloy had also argued that the tax violated the Import-Export Clause, which bars states from imposing tariffs on imports, although it is not settled that it applies domestically and not just internationally. The Court did not address this interesting argument, having already concluded the tax was unconstitutional.

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