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General Telephone Co. v. Johnson

OPINION FILED OCTOBER 3, 1984.

GENERAL TELEPHONE COMPANY OF ILLINOIS, APPELLEE,

v.

J. THOMAS JOHNSON, DIRECTOR OF REVENUE, ET AL., APPELLANTS.



Appeal from the Circuit Court of Sangamon County, the Hon. Simon L. Friedman, Judge, presiding.

CHIEF JUSTICE RYAN DELIVERED THE OPINION OF THE COURT:

This appeal concerns the apportionment factor used by a corporation doing business in more than one State which must allocate a portion of its invested capital to Illinois before computing its invested-capital tax liability under our Messages Tax Act (Ill. Rev. Stat. 1981, ch. 120, par. 467.1 et seq.; Ill. Rev. Stat., 1982 Supp., ch. 120, par. 467.1). Plaintiff, General Telephone Company of Illinois (the taxpayer), brought this taxpayer's protest action on March 5, 1982, against defendants, the Director of the Illinois Department of Revenue and the State Treasurer. The taxpayer sought a judicial determination of whether section 1 of the Messages Tax Act (Ill. Rev. Stat. 1981, ch. 120, par. 467.1) authorized the use of combined apportionment, a computation which would reduce the taxpayer's apportionment factor and accordingly reduce its invested-capital tax liability. Following the procedure of "An Act in relation to the payment and disposition of moneys received by officers and employees of the State of Illinois * * *" (Ill. Rev. Stat. 1981, ch. 127, par. 170 et seq.) ("the Protest Act"), the taxpayer computed the last quarterly installment of its 1981 invested-capital tax and the first installment of its 1982 tax without using combined apportionment. The resulting amounts of tax were paid into a special protest fund. According to the Protest Act (Ill. Rev. Stat. 1981, ch. 127, par. 172), the State Treasurer was to transfer the protest payments in 30 days to the appropriate State revenue fund unless by that time the taxpayer had obtained a temporary restraining order or preliminary injunction against their transfer.

The taxpayer then filed a complaint in the circuit court of Sangamon County which sought an injunction against defendants transferring money from the protest fund. The complaint requested a refund of taxes paid in excess of amounts which would be due had combined apportionment been used, and it also sought an injunction against further collection of invested-capital taxes computed in any method other than by using combined apportionment. With the complaint, the taxpayer filed a motion for a temporary injunction to prevent the transfer of monies from the protest fund, as well as to bar defendants from taking action against the taxpayer, until further order of the court. The trial court granted the motion for temporary injunction in an order entered on March 10, 1982. This order indicated that, as further installments of its 1982 invested-capital tax became due, the taxpayer should continue paying the installments under protest as required by the Protest Act (Ill. Rev. Stat. 1981, ch. 127, pars. 172, 172a).

After the temporary injunction issued, but before the trial court conducted a hearing on the merits, the General Assembly enacted Public Act 82-1024, "An Act in relation to State taxes." (82d Ill. Gen. Assem., 1982 Sess., 1982 Ill. Laws 2917, secs. 2-4, at 2921, 2923, 2924-25 (Ill. Rev. Stat., 1982 Supp., ch. 120, par. 467.1)). Effective December 15, 1982, this Act amended invested-capital tax provisions so as to prohibit the use of combined apportionment for purposes of the Messages Tax Act, the Gas Revenue Tax Act (Ill. Rev. Stat. 1981, ch. 120, par. 467.16 et seq.), and the Public Utilities Revenue Act (Ill. Rev. Stat. 1981, ch. 120, par. 468 et seq.). Public Act 82-1024 applied retroactively to 1979, the year when invested-capital taxes first were imposed.

In March 1983, the taxpayer moved for summary judgment on the issues of its complaint for injunction. The parties submitted briefs and in May 1983 argued the motion for summary judgment before the trial court. In July, the court concluded that, insofar as it retroactively prohibited combined apportionment, Public Act 82-1024 violated the due process principles of our Federal and State constitutions. An order was entered which granted the taxpayer's motion for summary judgment. The order directed the State Treasurer to transfer from the protest fund to the appropriate State revenue fund the amount of 1981 and 1982 taxes due from the taxpayer as computed using combined apportionment. Money in the protest fund in excess of those taxes was to be refunded to the taxpayer, along with the compound interest that the overpayment had earned. The order stated that if the Treasurer was unable to pay the compound interest in cash immediately, he should issue credit memoranda to the taxpayer for the interest owing. Because the trial court held a statute of this State to be invalid, defendants appealed directly to this court pursuant to our Rule 302(a)(1) (87 Ill.2d R. 302(a)(1)).

The first issue presented by this appeal is whether Public Act 82-1024, by prohibiting the use of combined apportionment, altered the law regarding invested-capital taxes in such a way that its retroactive effect interferes with the taxpayer's right to due process. To resolve this issue, we must examine the details of this taxpayer's protest suit, as well as the Messages Tax Act language imposing the invested-capital tax, in light of some related developments concerning the Illinois Income Tax Act (Ill. Rev. Stat. 1981, ch. 120, par. 1-101 et seq.).

Before considering the relevant provisions of our revenue laws, however, it is helpful to recognize several accounting principles that operate in the State income tax context. These principles concern a corporate taxpayer that draws business income from more than one State. In such cases, the amount of income fairly attributable to activities within the taxing State must be discerned before income tax constitutionally may be imposed. (See Container Corp. of America v. Franchise Tax Board (1983), 463 U.S. 159, 164, 77 L.Ed.2d 545, 552, 103 S.Ct. 2933, 2939.) If a single corporate taxpayer owns two distinct businesses, one located in the taxing State and the other located in another State, the taxpayer is likely able to separately account for the income of each business. In an accurate fashion, he then can allocate business income to the taxing State based on this separate accounting. Dexter, The Unitary Concept in State Income Taxation of Multistate-Multinational Businesses, 10 Urb. L. Rev. 181, 181 (1978).

If the tax-paying corporation conducts a single, functionally integrated business in several States, however, separate accounting probably is inadequate for allocating income to a taxing State. Such a concern, frequently called a unitary business, is exemplified by a corporation that owns a centrally managed and marketed hotel chain located in several States. Another example is a corporation engaged in manufacturing which locates central management and plant operations in one State; research and development activities in a second State; and warehousing, marketing, and distribution operations in all 50 States. Many income-taxing States have developed formulas for allocating to their States the appropriate portion of income from these unitary businesses. Thus, what is referred to as "formula apportionment" is available for income allocation in cases where separate accounting does not suffice. Container Corp. of America v. Franchise Tax Board (1983), 463 U.S. 159, 165, 77 L.Ed.2d 545, 553, 103 S.Ct. 2933, 2940; see generally Dexter, The Unitary Concept in State Income Taxation of Multistate-Multinational Businesses, 10 Urb. L. Rev. 181, 181-83 (1978); Comment, State Taxation of Corporate Income: Formulary Apportionment of Income Earned in Interstate Commerce, 48 Mo. L. Rev. 719, 720-22 (1983).

The Illinois Income Tax Act, which imposes a tax on net income (Ill. Rev. Stat. 1981, ch. 120, par. 2-201), reflects these accounting concepts. If a corporation does business in Illinois and one or more other States, section 304(a) of the Act directs this taxpayer to apply formula apportionment when allocating business income to Illinois. The formula-apportionment method prescribed by section 304(a) first requires that the taxpayer compute three factors, which are based on his property, payroll, and sales. The property factor is a fraction whose numerator is the taxpayer's Illinois property, and whose denominator is all of the taxpayer's property. The payroll and sales factors are computed similarly (i.e., Illinois payroll/all payroll; Illinois sales/all sales). Section 304(a) then requires the taxpayer to average the three factors, with the resulting fraction being the taxpayer's "apportionment factor." The section 304(a) apportionment factor is the percentage of the taxpayer's business income that will be taxed in Illinois. (Ill. Rev. Stat. 1981, ch. 120, par. 3-304(a).) Section 304(a) does not limit formula apportionment to cases where the taxpayer's business is unitary. However, if the formula-apportionment method set out in section 304(a) does not fairly represent the corporate taxpayer's Illinois business activity, several other allocation methods, including separate accounting, are available if determined to be reasonable. Ill. Rev. Stat. 1981, ch. 120, par. 3-304(e) (now Ill. Rev. Stat. 1983, ch. 120, par. 3-304(f)).

Beginning in 1969, the first year of the Illinois income tax, corporate taxpayers in this State applied section 304(a) formula apportionment in the manner just described. In 1981, however, Caterpillar Tractor Co. v. Lenckos (1981), 84 Ill.2d 102, presented this court with the question whether sections 301 and 304(a) of the Income Tax Act authorized a corporate taxpayer to derive its section 304(a) apportionment factor through a method that is known as combined apportionment. Like the ordinary formula apportionment that section 304(a) sets out, combined apportionment is a method for allocating a fair portion of business income to a taxing State. It was developed for use where a corporate taxpayer is a member of a closely associated group of corporations that collectively engages in a multistate unitary business ("a unitary business group"). When a corporate taxpayer is a member of such a group, ordinary section 304(a) formula apportionment — which considers only the property, payroll, sales, and business income of an individual corporation — often does not fairly depict the amount of the unitary business group's income that has resulted from the individual corporate taxpayer's activities within the taxing State. To resolve this problem, combined apportionment employs a formula which is similar to that set out in section 304(a), but which takes into account the property, payroll, sales, and business income of the entire unitary business group; that is, all of the corporations of the group. Caterpillar Tractor Co. v. Lenckos (1981), 84 Ill.2d 102, 108-09.

The language itself of section 304(a) does not authorize combined apportionment. However, corporations that were plaintiffs in Caterpillar Tractor Co. v. Lenckos argued that, as members of a unitary business group, they should be allowed under section 304(a) to apply combined apportionment in the following manner: First, the business income of each corporate member of the group would be computed so that the total business income of the group could be derived. Then, to determine the apportionment factor for a group member subject to the Illinois income tax, the property, payroll, and sales factors would be computed by using the individual group member's Illinois property, payroll, and sales as numerators, and the entire unitary group's property, payroll, and sales as denominators. The average of these three factors would be the group member's apportionment factor. This apportionment factor then would be applied to the group's total business income to derive the amount of business income on which the group member would pay Illinois income tax. See Caterpillar Tractor Co. v. Lenckos (1979), 77 Ill. App.3d 90, 98, aff'd (1981), 84 Ill.2d 102.

In Caterpillar, this court approved the use of combined apportionment under section 304(a) of the Income Tax Act. To reach that decision, we first considered the allocation difficulties that State taxing authorities encounter when a unitary business group member is to be taxed on its income attributable to activities within Illinois. (84 Ill.2d 102, 116.) According to courts that previously had considered this issue, we noted, the absence of express statutory provision for combined apportionment is not the critical test of whether the method is authorized by a particular State's income tax statute. (84 Ill.2d 102, 118-20.) After examining the legislative history of our Income Tax Act, as well as the General Assembly's emphasis on fairly determining income tax liability, we concluded that "the use of the combined or unitary apportionment method is authorized under the Act and could be required by the Department [of Revenue] in the case of unitary business groups." 84 Ill.2d 102, 121.

In February 1981, then, we approved combined apportionment for application to the combined worldwide income of Caterpillar Tractor Company and its 25 subsidiaries. The next year, our General Assembly addressed combined apportionment in an amendment to the Income Tax Act. (Pub. Act 82-1029, 82d Ill. Gen. Assem., 1982 Sess., 1982 Ill. Laws 2946 (Ill. Rev. Stat. 1983, ch. 120, pars. 2-203(b)(2)(J), 3-304(a)(3)(B)(ii), 3-304(e), 15-1501(a)(28)).) The amendment added a provision that expressly requires combined apportionment for taxpayers who, by statutory definition, are unitary business group members. (Ill. Rev. Stat. 1983, ch. 120, pars. 3-304(e), 15-1501(a)(28).) The legislature rejected worldwide combined apportionment, however, and instead adopted a domestic version which excludes from the unitary business group any member whose activities are carried on primarily outside of the United States. This domestic combined apportionment also strictly limits formulary consideration of foreign dividend income, as well as sales between United States ...


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