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06/10/87 Searle Pharmaceuticals, v. the Department of Revenue

June 10, 1987

SEARLE PHARMACEUTICALS, INC., APPELLANT

v.

THE DEPARTMENT OF REVENUE, APPELLEE. -- CATERPILLAR TRACTOR CO. ET AL., APPELLANTS,

v.

J. THOMAS JOHNSON, DIRECTOR OF REVENUE, APPELLEE



SUPREME COURT OF ILLINOIS

512 N.E.2d 1240, 117 Ill. 2d 454, 111 Ill. Dec. 603 1987.IL.775

No. 63151. -- Appeal from the Appellate Court for the First District; heard in that court on appeal from the Circuit Court of Cook County, the Hon. Earl Arkiss, Judge, presiding. No. 63228. -- Appeal from the Circuit Court of Peoria County, the Hon. Robert E. Manning, Judge, presiding.

APPELLATE Judges:

JUSTICE RYAN delivered the opinion of the court. JUSTICE GOLDENHERSH took no part in the consideration or decision of this case.

DECISION OF THE COURT DELIVERED BY THE HONORABLE JUDGE RYAN

These consolidated appeals involve various challenges to the constitutionality of the 1977 amendment of section 203(e)(2)of the Illinois Income Tax Act (Ill. Rev. Stat. 1979, ch. 120, par. 2-203(e)(2)) (the Act), which provided that any corporation which was a member of an affiliated group of corporations filing a consolidated Federal income tax return, incurring a net operating loss on a separate Illinois income tax return basis, be deemed to have made the election provided in section 172 of the Internal Revenue Code (26 U.S.C. sec. 172(b)(3)(1982)), that is, to relinquish the entire carryback period and only carry forward the loss.

Because the relationship between the Illinois Income Tax Act and the Internal Revenue Code is of primary importance to an understanding of this cause, we will briefly summarize the applicable statutory provisions in force during the relevant period. Under the Internal Revenue Code, corporations which are members of a parent-subsidiary affiliated group of corporations may file a single Federal income tax return for a taxable year in which all of their tax items are consolidated. (26 U.S.C. sec. 1501 (1982).) Once a valid consolidated return election has been filed, the affiliated group must continue to file consolidated Federal returns in subsequent taxable years unless it has secured permission from the Internal Revenue Service to discontinue the filing of such returns. 26 U.S.C. secs. 1501, 1502 (1982); Treas. Regs. sec. 1.1502 -- 75(c) (1983).

Under the Illinois Income Tax Act, a tax measured by net income is imposed on every corporation for each taxable year ending after July 31, 1969, on the privilege of earning or receiving income in or as a resident of this State. (Ill. Rev. Stat. 1979, ch. 120, par. 2-201(a).) Net income is that portion of the taxpayer's base income for such taxable year which is allocable to this State less the standard allowable exemption. (Ill. Rev. Stat. 1979, ch. 120, par. 2-202(a).) A corporation's base income is equal to the taxpayer's taxable income for the taxable year for Federal income tax purposes, subject to certain adjustments not directly relevant here. (Ill. Rev. Stat. 1979, ch. 120, pars. 2-203(b)(1), (b)(2).) Taxable income is defined by the Act as "taxable income properly reportable for federal income tax purposes for the taxable year under the provisions of the Internal Revenue Code." (Ill. Rev. Stat. 1979, ch. 120, par. 2-203(e)(1).) If a corporate taxpayer has filed a consolidated Federal income tax return, however, the Act provides that taxable income is "determined as if such corporation had filed a separate return for federal income tax purposes for the taxable year and each preceding taxable year for which it was a member of an affiliated group." (Emphasis added.) (Ill. Rev. Stat. 1979, ch. 120, par. 2-203(e)(2)).) In addition, by virtue of the amendment to section 203(e)(2)effective September 12, 1977, the corporate taxpayer's separate taxable income is computed as if the election provided by section 172(b)(3)of the Internal Revenue Code had been in effect for all such taxable years. (Ill. Rev. Stat. 1979, ch. 120, par. 2-203(e)(2).) Section 172 of the Internal Revenue Code allows a net operating loss to be carried back to reduce taxable income for the three taxable years preceding the taxable year in which the loss was sustained. (26 U.S.C. secs. 172(a), (b)(1)(1982).) Section 172 further provides that "[a]ny taxpayer entitled to a carryback period . . . may elect to relinquish the entire carryback period with respect to a net operating loss for any taxable year ending after December 31, 1975. Such election, once made for any taxable year, shall be irrevocable for that taxable year." (Emphasis added.) (26 U.S.C. sec. 172(b)(3)(1982).) The combined operation of these provisions thus serves to establish Federal taxable income (U.S. Form 1120, line 30) as the starting point upon which Illinois income tax liability is computed for a corporate taxpayer. Thus, the mandatory election to relinquish the carryback period applies only to corporations of an affiliated corporate group that files a consolidated Federal return and not to corporations of an affiliated corporate group that file separate Federal returns.

Section 506 of the Illinois Income Tax Act provides that, in the event the taxable income, any item of income or deduction, or the income tax liability reported in a Federal income tax return is altered by amendment, recomputation, or redetermination, and such alteration reflects a change or settlement with respect to any item(s) entering into the computation of the taxpayer's base income, the taxpayer shall notify the Department of Revenue of such change in the form of an amended return. (Ill. Rev. Stat. 1983, ch. 120, par. 5-506(b).) Section 911 of the Act provides that where notification of an alteration is required by section 506(b), a claim for refund may be filed with the Department of Revenue, limiting the amount recoverable to any overpayment resulting from the recomputation of the taxpayer's base income for the taxable year after giving effect to the item(s) reflected in the alteration. (Ill. Rev. Stat. 1979, ch. 120, par. 9-911(b)(1).) These sections thus authorize a refund of State taxes when a change in Federal taxable income resulting from a net operating loss carryback effects a change in State base income.

In cause No. 63151, Searle Pharmaceuticals, Inc. (Searle), the taxpayer, is a wholly owned subsidiary of G.D. Searle & Company (G.D. Searle) (the parent). Pursuant to the privilege set forth in section 1501 of the Internal Revenue Code, G.D. Searle and its subsidiaries consented to the filing of a consolidated United States Corporation Income Tax Return (U.S. Form 1120). For the taxable year ending December 31, 1977, G.D. Searle and its consolidated subsidiaries, including Searle, filed a consolidated Federal corporate income tax return reporting a net operating loss of $22,919,533 (U.S. Form 1120, line 30), later amended to $23,935,337. G.D. Searle and its subsidiaries timely carried back this consolidated net operating loss for Federal income tax purposes and deducted it in arriving at consolidated Federal taxable income for the taxable year ending December 31, 1974.

As discussed above, a corporation whose taxable income is included in a consolidated Federal income tax return with its subsidiaries is required to recompute its Federal taxable income on a separate return basis to arrive at its State base income. Searle accordingly prepared an Illinois Corporation Income Tax Return (Form IL-1120) for 1977, attaching pro forma copies of schedules L, M-1, M-2, and page 1 of U.S. Form 1120 as if it had filed a separate Federal return. Illinois Form IL-1120 requires, as the starting point for the calculation of Illinois base income, that Federal taxable income be entered on line 1, and states specifically that this amount is to be taken from line 30 of the U.S. Federal Form 1120. Searle thus reported for State tax purposes (Form IL-1120, line 1) $7,005,123 of the consolidated net operating loss as

In compliance with sections 506(b) and 911(b)(1) of the Act, Searle filed an amended Illinois corporate income tax return for 1974, attempting to carry back its 1977 income loss ($7,005,123), as reflected on its pro forma Federal return, to reduce its 1974 Federal taxable income for Illinois tax purposes (i.e., base income) from $4,951,137 to zero, and seeking a State tax refund of $103,193. On that same date, Searle filed an amended Illinois corporate income tax return for 1975, attempting to carry back the remainder of its 1977 pro forma return loss to reduce its 1975 Federal taxable income for Illinois tax purposes (i.e., base income) from $4,946,610 to $2,892,624, and seeking a State tax refund of $44,032.

The defendant, the Illinois Department of Revenue (Department), denied Searle's claims for refunds for the taxable years ending 1974 and 1975. A hearing officer rejected Searle's claims for refund, concluding that the plain language of section 203(e)(2)of the Act as amended in 1977 required that any corporation which is a member of a parent-subsidiary affiliated group of corporations electing to file a consolidated Federal corporate income tax return be deemed to have made the carryback relinquishment election set forth in section 172 of the Internal Revenue Code (26 U.S.C. sec. 172(b)(3)(1982)), such that net operating losses may only be carried forward for purposes of reducing State tax liability.

Upon denial of its claims for refund, Searle filed a complaint for administrative review in the circuit court of Cook County challenging the constitutionality of section 203(e)(2)of the Act as a denial of equal protection (U.S. Const., amend XIV; Ill. Const. 1970, art. I, sec. 2) and uniformity of taxation (Ill. Const. 1970, art IX, sec. 2). The circuit court, finding (1) that there was a set of facts that justified the classification between parent-subsidiary affiliates filing a consolidated Federal corporate income tax return and affiliates filing separate Federal corporate income tax returns, and (2) that the classification bore a rational relationship to a legitimate legislative purpose, affirmed the decision of the hearing officer and upheld the constitutionality of section 203(e)(2).

The appellate court, with one Justice Dissenting, affirmed the circuit court's judgment. (140 Ill. App. 3d 248.) The appellate court majority concluded that the disparity in tax treatment between a parent-subsidiary affiliated group electing to file a consolidated Federal corporate income tax return and affiliated corporate group electing to file separate Federal income tax returns was rationally related to the legitimate State interests of preserving appropriated financial resources, facilitating budgetary planning, aiding in administrative convenience, and preventing a corporate taxpayer's use of the carryback election to reduce its Illinois taxes to a maximum extent. (140 Ill. App. 3d 248, 252-56.) We allowed Searle's petition for leave to appeal pursuant to our Rule 315 (103 Ill. 2d R. 315).

In cause No. 63228, Caterpillar Industrial Products, Inc., Caterpillar of Delaware, Inc., Caterpillar Americas Company, Towmotor Corporation, and Production Technology, Inc., are wholly owned subsidiaries of the Caterpillar Tractor Company (Caterpillar) (the parent). Pursuant to the privilege set forth in section 1501 of the Internal Revenue Code, Caterpillar and its subsidiary corporations consented to the filing of a consolidated Federal income tax return. For the taxable years ending December 31, 1982 and 1983, the returns showed net operating losses of $587,009,772 and $594,503,892, respectively. Caterpillar and its subsidiaries timely carried back those consolidated net operating losses for Federal income tax purposes and deducted them in arriving at consolidated Federal taxable income for the taxable years ending December 31, 1979, 1980, and 1981.

In accordance with section 203(e)(2)of the Act, Caterpillar and its subsidiaries had filed Illinois Corporation Income Tax Returns for 1979, 1980, and 1981, attaching separate pro forma Federal income tax returns, and had paid Illinois income taxes for those years in the aggregate amounts of $14,566,670, $20,186,364, and $20,337,130, respectively. After having carried back losses for Federal tax purposes for 1981 and 1983, Caterpillar and its subsidiaries timely filed separate claims for refund of 1979, 1980, and 1981 Illinois income taxes with the Department of Revenue, asserting that they were entitled to carry back and deduct 1982 and 1983 consolidated net operating losses in the taxable years 1979, 1980, 1981. The defendant, the Director of the Department of Revenue, denied the refund claims on the ground ...


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