Appeal from Circuit Court of Sangamon County. No. 93CH122. Honorable Donald M. Cadagin, Judge Presiding.
As Corrected September 16, 1997.
Honorable Robert W. Cook, J., Honorable Rita B. Garman, J. - Concur, Honorable John T. McCullough, J. - Dissent. Justice Cook delivered the opinion of the court.
The opinion of the court was delivered by: Cook
JUSTICE COOK delivered the opinion of the court:
A.B. Dick Company (A.B. Dick) and its wholly owned subsidiaries, A.B. Dick Acceptance Corporation (Acceptance) and Videojet Systems International (Videojet), filed separate Illinois income tax returns for the tax years ending March 31, 1986, 1987, and 1988. During audit, the companies amended their returns and filed a single combined return for each year, alleging the companies were a unitary business group within the meaning of section 1501(a)(27) of the Illinois Income Tax Act (Tax Act) (now 35 ILCS 5/1501(a)(27) (West Supp. 1995)). Under the amended returns, the companies claim they are owed a refund of $1.2 million. The Department of Revenue (Department) concluded that A.B. Dick and Acceptance were parts of a unitary business, but that Videojet was not. As a result of the audit the Department determined that Acceptance owed a deficiency of $2,450. Acceptance paid that amount under protest and filed a verified complaint in the circuit court of Sangamon County pursuant to the State Officers and Employees Money Disposition Act (now 30 ILCS 230/1 through 6a (West 1994)) seeking return of the tax, interest and penalties paid under protest. The circuit court, in a one-paragraph docket entry, ruled in favor of the Department. The taxpayer appeals. We reverse and remand.
It is not an easy question what part of a corporation's income should be taxed in a particular state when that corporation does business in several states. The question is even more complicated when the multistate business is carried on by an associated group of corporate entities. See Citizens Utilities Co. v. Department of Revenue, 111 Ill. 2d 32, 39, 488 N.E.2d 984, 986, 94 Ill. Dec. 737 (1986); Caterpillar Tractor Co. v. Lenckos, 84 Ill. 2d 102, 108, 417 N.E.2d 1343, 1347, 49 Ill. Dec. 329 (1981). There are constitutional limitations on the power of a state to tax income arising out of interstate activities. A state has the power to tax out-of-state activities of associated corporations by formula apportionment only when the corporations constitute a "unitary business." Container Corp. v. Franchise Tax Board, 463 U.S. 159, 165-67, 77 L. Ed. 2d 545, 553-54, 103 S. Ct. 2933, 2940-41 (1983). The question whether there is a "unitary business" in the present case is one of statutory interpretation, not constitutional power, but the statute employs terms that have been defined in the constitutional cases.
The statute provides, in pertinent part:
"The term 'unitary business group' means a group of persons related through common ownership whose business activities are integrated with, dependent upon and contribute to each other. *** Unitary business activity can ordinarily be illustrated where the activities of the members are: (1) in the same general line (such as manufacturing, wholesaling, retailing of tangible personal property, insurance, transportation or finance); or (2) are steps in a vertically structured enterprise or process (such as the steps involved in the production of natural resources, which might include exploration, mining, refining, and marketing); and, in either instance, the members are functionally integrated through the exercise of strong centralized management (where, for example, authority over such matters as purchasing, financing, tax compliance, product line, personnel, marketing and capital investment is not left to each member)." 35 ILCS 5/1501(a)(27) (West Supp. 1995).
More than common ownership is required for a unitary business. The fact that a holding company owns controlling interest in several corporations is not enough to make the group a unitary business. Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 440, 63 L. Ed. 2d 510, 523, 100 S. Ct. 1223, 1233 (1980) (unitary business, however, where dividends represent profits derived from a functionally integrated enterprise). There must be something "'beyond the mere flow of funds arising out of a passive investment or a distinct business operation.'" Citizens Utilities, 111 Ill. 2d at 47, 488 N.E.2d at 990, quoting Container Corp., 463 U.S. at 166, 77 L. Ed. 2d at 554, 103 S. Ct. at 2940. There must be more than the type of occasional oversight "'that any parent gives to an investment in a subsidiary.'" Container Corp., 463 U.S. at 180 n.19, 77 L. Ed. 2d at 563 n.19, 103 S. Ct. at 2948 n.19, quoting F.W. Woolworth Co. v. Taxation & Revenue Department, 458 U.S. 354, 369, 73 L. Ed. 2d 819, 831, 102 S. Ct. 3128, 3138 (1982). Section 1501(a)(27) of the Tax Act imposes three requirements: (1) that there be common ownership, (2) that the companies be in the same general line of business, and (3) that there be functional integration through the exercise of strong centralized management. 35 ILCS 5/1501(a)(27) (West Supp. 1995). Only the third requirement is at issue in this case.
Some cases seem to indicate that "functional integration" refers to the operations of a company and that functional integration is a separate concept from centralized management. F.W. Woolworth, 458 U.S. at 364-66, 73 L. Ed. 2d at 828-29, 102 S. Ct. at 3135-36; see also Mobil, 445 U.S. at 438, 63 L. Ed. 2d at 521, 100 S. Ct. at 1232 ("contributions to income resulting from functional integration, centralization of management, and economies of scale"). It seems logical that whenever there is functional integration of operations there is also strong centralized management and vice versa. Section 1501(a)(27) of the Tax Act rejects the idea there are two separate tests. If functional integration has been shown, or if strong centralized management has been shown, then there is a unitary business.
A.B. Dick is a Delaware corporation with its principal office in Niles, Illinois. It manufactures and sells a variety of office and business printing and duplicating equipment. Acceptance was a wholly owned subsidiary of A.B. Dick that provided financing for purchasers of A.B. Dick equipment. During the pendency of this appeal, Acceptance was liquidated into A.B. Dick, which succeeded to Acceptance's rights and obligations. Over the course of several years A.B. Dick developed a type of noncontact printing known as ink-jet technology. For a time, this product line, called the "Videojet" line, was manufactured and marketed by A.B. Dick. On January 1, 1985, however, A.B. Dick incorporated Videojet, a wholly owned subsidiary, to which A.B. Dick transferred its Videojet line of assets, including machinery, equipment, materials, supplies and inventory. A.B. Dick also contributed or licensed 41 patents to Videojet. According to A. Harris Walker, the Videojet line was incorporated because the line was growing and they wanted to measure the line's performance, they wanted to more closely monitor what the business was doing.
David Powell is the chairman and president of A.B. Dick. He is also the chairman of Videojet. Henry J. Bode is the vice president of A.B. Dick, and is also the president of Videojet. Bode testified that, prior to Videojet's incorporation in 1985, he had been employed by A.B. Dick since 1972. Videojet's board of directors consists of Powell and Bode. A. Harris Walker, general counsel of A.B. Dick, is the secretary of both companies. Pat Hoffman is the assistant secretary of both companies. Kenneth Levin, the chief financial officer of A.B. Dick, exercised control over Videojet, determining, for example, how much Videojet cash should be transferred to A.B. Dick. There was testimony that both before and after incorporation Powell, Levin, and Walker managed A.B. Dick and Videojet as if the two were a single company.
Purchasing. Videojet had a separate purchasing department, but Videojet's purchase requests for equipment costing more than $500 were reviewed by Levin and approved by Powell. A.B. Dick's general counsel had to approve all Videojet real estate contracts and some contracts for the purchase of personal property.
Financing. All Videojet funds not immediately needed for operations were transferred to A.B. Dick as an intercompany loan. Since 1986, those loans bore interest, but that interest was never paid; instead it was treated as a dividend at year end. In March 1988, A.B. Dick provided financing for Videojet's acquisition of the Cheshire Division of Xerox Company through a $12 million interest-free loan. Since 1990, Videojet has occupied a new headquarters and manufacturing facility in Wood Dale, Illinois. The lessor required ...