Appeal from the Circuit Court of Morgan County; the Hon.
Gordon D. Seator, Judge, presiding.
JUSTICE TRAPP DELIVERED THE OPINION OF THE COURT:
Farmers & Traders State Bank (Taxpayer) brought this action to review the 1981 assessment of a deficiency by the Illinois Department of Revenue (Department). Taxpayer challenges the Department's inclusion of interest earned from 1975 through 1977 on certain Government National Mortgage Association (GNMA) securities (Ginnie Maes) and on Federal National Mortgage Association (FNMA) securities (Fannie Maes). The trial court upheld the Department's position and this appeal followed.
The issues on appeal are: (1) Whether the interest earned on Ginnie Maes is constitutionally immune or statutorily exempt from State taxation; (2) whether the interest earned on Fannie Maes is constitutionally immune or statutorily exempt from State taxation; (3) whether the Department's hearing procedure denied Taxpayer due process of law since the hearing examiner also represented the Department; and (4) whether the burden of proof was improperly placed on Taxpayer at the administrative hearing.
On July 23, 1980, the Department issued a notice of deficiency to Taxpayer in the amount of $12,777.73. Taxpayer filed a protest contesting disallowance of the following as base income subtractions: (1) For the year 1975, $73,600.02 interest earned on Fannie Mae certificates and $5,280.28 in interest earned on Ginnie Mae certificates; (2) in 1976, $125,493.29 in interest earned on Fannie Mae certificates and $7,091.36 in interest earned on Ginnie Mae certificates; and (3) in 1977, $99,087.51 in interest earned on Fannie Mae certificates and $16,623.86 in interest earned on Ginnie Mae certificates. Between December 1980 and April 1981, the appointed hearing officer sent six letters to Taxpayer delineating the authorities and documents on which the Department would rely in the administrative hearing.
On April 29, 1981, the administrative hearing was opened. Prior to continuing the hearing on plaintiff's motion, the hearing officer presented some 36 exhibits on the record, including case authorities considered and Department records pertaining to Taxpayer. The proceeding was continued on May 20, 1981.
On May 20, 1981, the hearing officer stated the Department had presented a prima facie case by admitting certain exhibits into evidence and taking official notice of others. Taxpayer moved for a dismissal on constitutional and procedural grounds. Dennis Little, Taxpayer's representative, testified on Taxpayer's behalf.
On November 4, 1981, the hearing officer signed his report ruling against Taxpayer on the issues raised. On December 2, 1981, the Director of Revenue issued a decision affirming the hearing officer's report. On January 5, 1982, Taxpayer filed this suit. The trial court upheld the agency's decision.
• 1 The first question raised by this appeal is whether the interest earned on Ginnie Mae certificates issued under 12 U.S.C. sec. 1721(g) (1976), guaranteed by GNMA and backed by the full faith and credit of the United States, is constitutionally immune from State taxation or constitutes "other obligations of the United States" and is therefore exempt from State taxation under 31 U.S.C. § 742 (1976). We find that the interest earned is not exempt for either reason.
The question of whether Ginnie Mae certificates themselves are subject to State taxation was resolved against the taxpayer in Montgomery Ward Life Insurance Co. v. Department of Local Government Affairs (1980), 89 Ill. App.3d 292, 411 N.E.2d 973. Therein the court described the operation of the Mortgage Backed Securities Program: A financial institution or a mortgage servicing company assembles or acquires a pool of government insured or guaranteed mortgages. GNMA enters into a "Guaranty Agreement" with that party (issuer). GNMA agrees to guarantee timely payments of principal and interest and the issuer agrees to remit in a timely manner all payments required by the terms of the securities. The private issuer is primarily liable to make the payments required by the securities and must proceed with due diligence in collecting the proceeds from the pool. When amounts equal to scheduled payments are not collected, the issuer has a duty to advance from its own funds amounts equal to the payments which should have been collected. This private issuer actively manages and controls the pool of mortgages backing the securities and is paid a fee for its services in administering the pool based on and payable from the interest portion of each monthly installment. If the issuer fails to make timely payments, the security holder's sole recourse is against GNMA. However, GNMA may treat the issuer's failure to make required payments as an event of default under the Guaranty Agreement and has the option of extinguishing the issuer's interest in the pooled mortgages and becoming owner of those mortgages subject only to the unsatisfied rights of the security holders. See New York Guardian Mortgagee Corp. v. Cleland (S.D.N.Y. 1979), 473 F. Supp. 409; and New York Guardian Mortgagee Corp. v. Cleland (S.D.N.Y. 1979), 473 F. Supp. 422.
The Montgomery Ward court reasoned as follows:
"Under the rule first enunciated in M'Culloch v. Maryland (1819), 17 U.S. (4 Wheat.) 316, 4 L.Ed. 579, all properties, functions and instrumentalities of the Federal government are immune from State and local taxation. (See Smith v. Davis (1944), 323 U.S. 111, 113, 89 L.Ed. 107, 110, 65 S.Ct. 157, 158-59.) To make this implied constitutional immunity explicit, Congress has provided for the exemption from State and local taxes for certain written obligations in 31 U.S.C. sec. 742 (1976). That section provides:
`Except as otherwise provided by law, all stocks, bonds, Treasury notes, and other obligations of the United States, shall be exempt from taxation by or under State or municipal or local authority. This exemption extends to every form of taxation that would require that either the obligations or the interest thereon, or both, be considered, directly or indirectly, in the computation of the tax, except nondiscriminatory franchise or other nonproperty taxes in lieu thereof imposed on corporations and except estate taxes or inheritance taxes.'
The basis of this statutory exemption is `the fact that a tax upon the obligations of the United States is virtually a tax upon the credit of the Government, and upon its power to raise money for the purpose of carrying on its civil and military operations.' Hibernia Savings & Loan Society v. City and County of San Francisco (1906), 200 U.S. 310, 313, 50 L.Ed. 495, 496, 26 S.Ct. 265, 266.
The credit instrumentalities of the United States recognized by the Supreme Court as constitutionally exempt from State and local taxation have been characterized by `(1) written documents, (2) the bearing of interest, (3) a binding promise by the United States to pay specified sums at specified dates and (4) specific Congressional authorization, which also pledged the faith and credit of the United States in support of the promise to pay.' (Smith v. Davis (1944), 323 U.S. 111, 114-15, 89 L.Ed. 107, 110, 65 S.Ct. 157, 159.) Such credit instrumentalities are issued in the exercise of the power of Congress to borrow money on the credit of the United States to finance an ...