Sweepstakes companies striking back

Lawsuits try to recoup 'excessive' taxes by cities
Jun. 15, 2013 @ 08:29 AM

A clause in the North Carolina constitution designed to ensure just and equitable taxation by local governments is being put to the test by companies the state has barred to do business.

The N.C. Supreme Court ruled March 8 that a business privilege license tax imposed by Lumberton on Internet sweepstakes operators exceeded constitutional bounds because it went from from $12.50 a year per machine to $135,000, a 59,900 percent increase.

Following that ruling, a growing number of municipalities are facing lawsuits by former sweepstakes operators. Among those are Lenoir, Hickory, Newton, Conover, Haw River, Sylva, Highlands and Macon County.

The fees and taxes involved generally are much less than was the case in Lumberton -- for instance, Lenoir's tax went from $500 per machine to $1,000, a 100 percent increase -- so the question will be how to determine what is just and equitable, and excessive, said Ed Blair, Lenoir's city attorney.

"The Lumberton case represented a change in the law," Blair said. "What is fair and just is ultimately for the Supreme Court to decide. But this is kind of a developing area of law. Are there facts that justify increases? Some of the cities have taken the position, 'Let them do busienss here, let us raise revenues.'"

The lawsuit against Lenoir by Clark Consulting Group, which did business in Lenoir as Highway 18 Sweepstakes, seeks $22,000 it says it paid in franchise fees and taxes, plus attorney's fees. Clark Consulting also is behind the lawsuits against Hickory, Newton and Conover.

Internet gaming businesses gained popularity after the General Assembly banned video poker in 2007. A loophole in the state's gambling law allowed customers to purchase computer time to play the games. Users also could spend that time word processing or checking e-mails, but the main draw was the lure of instant cash.

Some municipalities decided either to try to cash in or require the operators to pay steeply if they wanted to stay in business. In 2012 Granite Falls proposed to raise its business privilege license tax on sweepstakes establishments from $500 per machine to $2,500, a 500 percent increase, but the town passed a lower rate of $1,000 per machine. Still, the measure kept at least one potential operator out of town, its owner citing the "discriminatory rate," and withdrew his conditional use permit.

In December 2012 the state Supreme Court upheld a state ban on sweepstakes businesses.

Jeanette K. Doran, executive director and general counsel for the North Carolina Institute for Constitutional Law, feels a careful balance must be struck between the power of government to impose a tax for legitimate reasons, and the right of the people to be "free of abuse of the taxing power."

"There is not set amount which I  (deem) necessarily unreasonable or unconstitutional," she said. "The emphasis is on equality and fair play. What constitutes an unconstitutional tax may vary based on the circumstances of the tax imposed, but what constitutes a constitutional tax will inevitably bear the hallmarks of freedom and fairness."

Mitch Kokai of the conservative think tank the John Locke Foundation said a tax increase could be justified if it paid for additional services to be provided. But the tipping point for deciding what is reasonable or excessive is a gray area.

"I don't know of any hard-and-fast threshold that would separate reasonable from excessive," he said. "That determination is based largely on context. If a municipality charges a fee to businesses operating within its jurisdiction, the fee generally ought to be applied in an equitable way to all legal businesses.

"I'm not certain whether state law permits it, but I could understand an argument from cities that they should be allowed to charge a higher fee for businesses that generate a substantially higher cost to the city. If a particular type of business requires much more police activity, fire protection, or other public services, a business fee scale that incorporated those additional taxpayer costs would seem to make sense. In the case of the sweepstakes companies, the higher fees seem to have been completely divorced from that sort of calculation. Instead, local governments seem to have decided that raising fees far above those charged to other businesses would either drive the sweepstakes operators out of business or generate a lot of new revenue."