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Caterpillar Tractor Co. v. Lenckos

OPINION FILED FEBRUARY 20, 1981.

CATERPILLAR TRACTOR CO. ET AL., APPELLANTS AND CROSS-APPELLEES,

v.

DANIEL J. LENCKOS, DIRECTOR OF REVENUE, ET AL., APPELLANTS AND CROSS-APPELLEES.



Appeal from the Appellate Court for the Third District; heard in that court on appeal from the Circuit Court of Peoria County, the Hon. Stephen J. Covey, Judge, presiding.

MR. JUSTICE WARD DELIVERED THE OPINION OF THE COURT:

Rehearing denied March 27, 1981.

The plaintiffs, Caterpillar Tractor Company and four of its corporate subsidiaries, filed separate Illinois corporate income tax returns for 1969 through 1974 inclusive. Each corporation, whose business income is generated through multistate and multinational business operations, in preparing its return applied the apportionment formula set out in section 304(a) of the Illinois Income Tax Act (Ill. Rev. Stat. 1969, ch. 120, par. 3-304(a)) for the use of corporations deriving business income from transactions in Illinois and in one or more other States. A purpose of the apportionment formula is to confine taxation to the portion of corporate income attributable to business operations within Illinois.

Under section 304(a), the Director of Revenue (Director) applies a three-factor (sales, payroll and property) apportionment formula which separately compares the total value of a corporation's in-State and out-of-State sales, payroll, and property, both tangible and intangible, with the total value of the corporation's in-State sales, payroll, and property alone. To illustrate: if the total multistate sales of a corporation are $10 million and its total Illinois sales are $1 million, the Illinois sales would represent one-tenth of the total multistate sales of the corporation, giving a sales factor of 10%. Once the percentage of the other factors, payroll and property, is calculated, the three factors are averaged. This average is then multiplied by the total amount of business income generated by the corporation's in-State and out-of-State operations. If, for example, the sales, payroll and property multistate factors of the corporation are each 10% and its combined business income is $20 million, the amount of business income attributable to Illinois is $2 million.

This method of apportionment was applied by each of the plaintiff corporations in order to determine the portion of income upon which Illinois could properly impose its corporate income tax. (Ill. Rev. Stat. 1969, ch. 120, par. 2-201(b)(2).) The Illinois tax paid by the five corporations for the six years in question totaled $37,238,681.60. The separate returns filed by each of the plaintiffs showed deductions claimed for taxes paid to foreign governments in other countries which had been credited for Federal income tax purposes. The plaintiffs also deducted certain dividend income includable in Federal taxable income (26 U.S.C. § 78 (1976)) as well as income obtained under subpart F of the Internal Revenue Code. 26 U.S.C. § 951 through 964 (1976).

Between February of 1974 and May of 1976, each of the plaintiffs filed separate claims with the Director for refunds covering 1969 through 1974. They claimed that for the period of 1970-74, by using separate apportionment they misapplied the apportionment formula of section 304(a) and, instead, should have applied the unitary method of apportionment when calculating the percentage of each plaintiff's business income attributable to operations within Illinois. Because of this misapplication, or failure to apply the unitary method, the plaintiffs claimed that each of them paid a greater tax than it was liable for under the Illinois Income Tax Act.

The unitary apportionment method or as it is described in the case of a group of commonly owned and controlled corporations, the combined reporting method of reporting the income of the plaintiffs from what are literally worldwide sources, should have been applied, the plaintiffs said, since they qualified as a unitary business group. A unitary business operation is one in which there is a high degree of interrelationship and interdependence between, typically, one corporation, which generally is a parent corporation, and its corporate subsidiaries or otherwise associated corporations, which group is usually engaged in multistate, and in some cases in international, business operations. Because of this integrated relationship, which is reflected in all phases of the business operations, it is extremely difficult, for purposes of taxation, to determine accurately the measure of taxable income generated within a State by an individual corporation of the unitary group which is conducting business in the State. Typically, the corporation's transactions and the income derived from them actually represent the business efforts of the individual corporation, plus efforts of other and possibly all members of the unitary business operation. As a result, the claimed income of each member of the group standing alone does not, in a real sense, reflect the conducting of a unitary business operation because the income is not attributable solely to the effort of the particular corporation.

The plaintiffs in their separately filed claims for refunds maintained that, in order to fairly measure the taxable business income of each unitary member, a unitary method of apportionment should have been applied. They argued that under this formula, which they asserted was authorized under section 304(a) of the Illinois Income Tax Act, each corporation's in-State, i.e., Illinois, data for its property, payroll and sales should have been compared with the combined worldwide totals of the entire unitary group, which included the plaintiffs and 21 other corporate subsidiaries of Caterpillar Tractor. The plaintiffs, in their State returns, compared only the in-State totals of each corporation with the in-State and out-of-State totals for property, payroll and sales of the same corporation and not of the unitary business group.

The plaintiffs argued that the unitary method of apportionment should be applied for each of the plaintiffs for the years 1970 through 1974 but not as to 1969. The basis for excluding 1969 was the contention that the unitary method of reporting did not accurately reflect the amount of taxable income for that year since the Illinois Income Tax Act did not take effect until August of 1969 (Ill. Rev. Stat. 1969, ch. 120, par. 1-101 et seq.). The proposed application by the plaintiffs of the unitary method of apportionment, and the claimed deductions for dividend income, subpart F income, and foreign income taxes paid, were denied by the Director. Timely protests were filed by the plaintiffs.

At the later administrative hearing, the plaintiffs introduced extensive evidence showing a strong integrated relationship between Caterpillar Tractor, the parent corporation, and its multistate and multinational subsidiaries. Based on this and on a strict policy of Caterpillar Tractor to maintain worldwide uniformity in all phases of its operations, including production, marketing and employer-employee relationships, all of which were kept subject to the central control of the parent corporation, the plaintiffs contended that they should be considered members of a unitary business group. The Director agreed and then applied a unitary apportionment formula under section 304 of the Illinois Income Tax Act (Ill. Rev. Stat. 1977, ch. 120, par. 3-304), using the combined worldwide business income of Caterpillar Tractor and its 25 subsidiaries in order to determine the appropriate percentage of business income attributable to Illinois for each corporate plaintiff for all six years in question, 1969 through 1974. The Director, however, denied the deductions claimed for the foreign income taxes, the deemed dividend income and the subpart F income.

The plaintiffs appealed to the circuit court of Peoria County (Ill. Rev. Stat. 1977, ch. 120, par. 12-1201) on the ground that unitary apportionment should not have been applied to their 1969 taxable income and on the ground that the Director erred in denying the various deductions claimed. The circuit court allowed the petitions of 16 corporations, including the Coca Cola Company, to intervene, but limited intervention to the issue of whether unitary apportionment is authorized under the Illinois Income Tax Act (Ill. Rev. Stat. 1977, ch. 120, par. 1-101 et seq.).

The circuit court subsequently held that combined reporting was authorized in Illinois and affirmed the Director's decision to combine the worldwide income of Caterpillar Tractor and its 25 subsidiaries for purposes of apportioning each plaintiff's Illinois taxable income for 1970 through 1974. With respect to 1969, it held that the unitary method of apportionment was, in general, inapplicable. The court held also that the plaintiffs could claim as deductions dividend income, subpart F income, and also foreign income taxes paid by domestic subsidiaries, as well as foreign income taxes paid by foreign subsidiaries.

The appellate court, on appeals by the plaintiffs, the Director, and the intervenors, affirmed the judgment as to the application of the unitary method for 1970-74 but held that the unitary method of apportionment was applicable for 1969. (77 Ill. App.3d 90, 101.) The court affirmed also the allowance of the petitions to intervene. It, however, also reversed the circuit court's allowance of the deductions claimed by the plaintiffs. We granted and consolidated petitions for leave to appeal filed by the plaintiffs, the Director and the intervenors and allowed the filing of a number of amicus curiae briefs. The plaintiffs did not seek an appeal from the holding that the ...


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