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Philco Corp. v. Department of Revenue





APPEAL from the Circuit Court of Sangamon County; the Hon. WILLIAM H. CHAMBERLAIN, Judge, presiding.


Each appellant, Philco Corporation (Philco) in No. 40497, and Rental Equipment Company, Inc., (Rental) in No. 40582, objected to Department of Revenue assessments under the Use Tax Act. (Ill. Rev. Stat. 1967, chap. 120, pars. 439.1-439.22.) The circuit court of Sangamon County affirmed the action of the Department in each case, and each appellant appealed directly to this court. Because of the similarity of the factual situations and the legal contentions of the parties in the two cases, they were consolidated for opinion.

Philco, a Pennsylvania corporation, leased a computer system to Barber-Colman Company, an Illinois corporation, for use by Barber-Colman at its plant in Rockford, Illinois. The lease was executed in Pennsylvania, and it obligated Philco to install "all components of the System at the site, make all necessary connections to power supply outlets, interconnect all components, and place the System in proper operating condition." It also required Philco to "keep the equipment in good operating condition" and "to have its maintenance personnel in attendance unless other mutually agreeable arrangements are made." Philco employs and pays two engineers who are "in residence at Barber-Colman." The lease is for an initial term of six years; and Barber-Colman is to return the computer system to Philco "in as good condition as when received, normal wear and tear excepted." Typical monthly rentals are between $20,000 and $25,000.

Philco delivered the computer system in October of 1961. The Department of Revenue assessed a use tax of $12,644.03 against Philco for use of the computer in Illinois. The tax was assessed at 3 1/2% of the cost of the materials that Philco had purchased from others and incorporated into the computer system, but with respect to which Philco had at no time paid sales or use tax. The tax was paid under protest, and Philco's claim for refund was denied.

Rental Equipment Company, Inc., is a Missouri corporation which engages in the business of renting heavy construction equipment. Rental leased certain equipment for use by lessees on construction projects in Illinois. Each lease was executed at Rental's St. Louis office, and the equipment was delivered to the lessee at Rental's yard in St. Louis. Rental reserved "the right to remove the equipment from the job at any time when, in its opinion, the equipment is in danger because of strikes or any other condition * * * [and] the privilege at all times of entering any job, building or location where the * * * property is being used for the purpose of inspection * * *." It further reserved "the privilege of removing said machinery and equipment on twenty-four hours' notice if it is being overloaded or taxed beyond its capacity or in any manner abused or neglected." The lessees were forbidden to move the equipment out of Illinois "without the written consent of the lessor." The lease also provided that "[s]hould any of the provisions * * * be violated by [the] lessee * * * the lessor, or its agents may, without notice, enter the premises occupied by [the] lessee without being a trespasser thereon and take possession of and remove said equipment with or without process of law." There is no evidence that the company or its representatives entered the State either to supervise the use of its equipment or to make repairs. As a courtesy to its lessees, Rental calls the union hall for men to operate its equipment, but these men do not go on Rental's "payroll except very rarely as a matter of emergency." This service is provided because Rental's customers think Rental "can get better men."

The Department assessed use tax in the sum of $20,506.07 and penalties of $4,553.91 against Rental for its use of the rented equipment in Illinois. The assessment was based on the purchase price of each item of equipment used in Illinois, "reduced by an amount which represents a reasonable allowance for depreciation for the period of * * * prior out-of-state use." (Ill. Rev. Stat. 1967, chap. 120, par. 439.3.) The Department refused to give Rental credit for Missouri sales taxes paid on equipment previously leased to Missouri residents because Rental had exercised its option under Missouri law to pass those taxes on to its customers.

Both appellants were taxed under the general Use Tax Act with respect to periods when the Leasing Use Tax Act was not in effect. (Ill. Rev. Stat. 1965, chap. 120, pars. 453.121-453.140, repealed by Act approved July 20, 1967, Laws of 1967, p. 1849, S.B. 1779.) They argue that as lessors they did not "use" their property in Illinois within the meaning of the Use Tax Act, and that the Department's assessments contravene the legislative intent that the Use Tax Act do no more than complement the Retailers' Occupation Tax Act. (Ill. Rev. Stat. 1967, chap. 120, pars. 440-53.) They also raise several constitutional objections to the Department's assessments. We turn first to a consideration of whether or not the General Assembly intended that these lessors should be subject to the tax.

The basic definition of the word "use" in the Use Tax Act when it was adopted in 1955 is the same definition that is contained in the present statute. "`Use' means the exercise by a person of any right or power over tangible personal property incident to the ownership of that property, * * *." Ill. Rev. Stat. 1967, chap. 120, par. 439.2.

After the Use Tax Act was enacted, the Department of Revenue promulgated its Rule No. 3, which stated: "The use tax does not apply to the rental payments made by a lessee to a lessor, but the lessor (not being a reseller) is legally the user of the property and is taxable on the purchase price thereof." (Ill. Use Tax Rule 8, Aug. 1, 1957.) This construction of the statute was approved in International Business Machines Corp. v. Department of Revenue, 25 Ill.2d 503, in which we said: "A mere lessee does not exercise over the property any rights or powers incident to the ownership of the property. Thus, in the absence of a change in the statutory definition of `use,' the lessee does not use the property in the statutory sense and is not subject to use tax." 25 Ill.2d at 510-11.

The Supreme Court of California, construing identical language, similarly held that the "statutory definition of `use' includes that exercise of dominion [over property] which takes the form of leasing it." (Union Oil Co. v. State Board of Equalization (1963), 60 Cal.2d 441, 386 P.2d 496, 500, appeal dismissed (1964), 377 U.S. 404, 12 L.Ed.2d 495.) The California court said: "Ownership is not a single concrete entity but a bundle of rights and privileges as well as of obligations. It finds expression through multiple methods. One such method is the lease. * * * The statutory definition recognizes that the term `use' covers the utilization of property for profit-making purposes by means of leasing; the word use is by no means restricted to physical manipulation." 386 P.2d at 500.

In our recent decision of Miller Brewing Co. v. Korshak, 35 Ill.2d 86, appeal dismissed, 386 U.S. 684, 18 L.Ed.2d 405, we applied the same principle in construing an identical definition of use contained in the Service Use Tax Act. (Ill. Rev. Stat. 1967, chap. 120, pars. 439.31-439.51.) We there stated that "[t]he power to allow property one owns to be used for one's benefit * * * is the `exercise' of an `incident of ownership' under the act." (35 Ill.2d at 93.) As one commentator has stated, "when a person buys property in one state for the purpose of leasing it and transporting it to a person in another state where a use tax law is in effect, the lessor is considered as using the property in the second state for the production of income and hence is subject to such state's use tax even though he personally makes no physical use of the property in such state." Keesling, Conflicting Conceptions of Ownership in Taxation (1956), 44 Calif. L. Rev. 866, 867.

We hold, therefore, that, as lessors of personal property who leased their machinery for use in Illinois, both Philco and Rental used that machinery in Illinois within the meaning of section 2 of the Use Tax Act. Ill. Rev. Stat. 1967, chap. 120, par. 439.2.

Both appellants also argue that regardless of the interpretation given the term "use", the following limitation in section 3 of the Use Tax Act makes the statute inapplicable to them: "If the seller of tangible personal property for use would not be taxable under the Retailers' Occupation Tax Act despite all elements of the sale occurring in Illinois, then the tax imposed by this Act shall not apply to the use of such tangible personal property in this State." (Ill. Rev. Stat. 1967, chap. 120, par. 439.3.) Philco argues, "Since transfers of possession, that is to say leasing, in transactions in which all elements had an Illinois situs were not covered by ROTA at any pertinent time, it is clear that the lease by Philco of the computer system to Barber-Colman in Pennsylvania, even if * * * otherwise covered * * *," was exempt under section 3.

Section 3, however, is not concerned with whether the lessor would have been taxable upon transferring possession of the property to the lessee; it is concerned with whether the person who sells the property to the lessor would have been taxable with respect to that sale. Its only purpose is to insure that the use tax do no more than complement the retailers' occupation tax by prohibiting a tax upon the use of property ...

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