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Borden Inc. v. Illinois Department of Revenue

March 27, 1998


Appeal from the Circuit Court of Cook County. No. 92 L 50493 The Honorable John A. Ward, Judge, Presiding.

The opinion of the court was delivered by: Justice Hourihane

Plaintiff, Borden, Inc. (Borden), appeals an order of the circuit court affirming a decision of the Director of the Illinois Department of Revenue (Director). The Director found that, for purposes of the Illinois Income Tax Act (Tax Act) (Ill. Rev. Stat. 1981, ch. 120, par. 1-101 et seq. (now 35 ILCS 5/101 et seq. (West 1996))), Borden's three Pepsi-Cola subsidiaries (Pepsi Subs) were part of Borden's "unitary business group" and the capital gains Borden realized from the sale of its Pepsi Subs stock in 1982 was "business income". We affirm.


Borden, a New Jersey corporation with its principal place of business in New York, is engaged in the manufacture and marketing of food, consumer, and chemical products and in the provision of related services. Borden operates in various states, including Illinois. In 1971, Borden acquired the Pepsi Subs as wholly owned subsidiaries. *fn1 The Pepsi Subs are independent bottlers which operate within designated geographical areas under exclusive bottling and syrup appointments with Pepsi-Cola Corporation (Pepsi), a Delaware corporation. The bottling and syrup appointments prohibit the Pepsi Subs from distributing any other "cola" and require the Pepsi Subs' participation in various advertising and promotional programs.

In January 1982, Borden sold the Pepsi Subs stock and realized a long-term capital gain in excess of $27,000,000. During the course of a subsequent tax audit, Borden advised the Department that Borden had incorrectly included the capital gain in its business income, rather than in its non-business income, and filed a valid claim for refund. Following the audit, Borden filed a Protest and Hearing Request, contesting the Department's determination that, for each of tax years 1981 and 1982, Borden and the Pepsi Subs were engaged in a unitary business operation, and that the gain realized by Borden on the sale of the Pepsi Subs stock was business income.

The administrative law Judge (ALJ) found that Borden and the Pepsi Subs were not engaged in a unitary business and that the gain on the sale of the stock was business income. The Director rejected the recommended decision of the ALJ that Borden and the Pepsi Subs did not conduct a unitary business, but concurred with the ALJ as to the inclusion of the capital gain as business income. Borden subsequently filed a complaint for administrative review. The circuit court found the Director's decision was not against the manifest weight of the evidence and affirmed the Director's decision in full. This appeal followed. 735 ILCS 5/3-112 (West 1996); 155 Ill 2d R. 301.


Unitary Business Group

Where a corporate taxpayer operates in more than one state, the amount of income fairly attributable to the taxing state must be determined before income tax may be constitutionally imposed. General Telephone Co. of Illinois v. Johnson, 103 Ill. 2d 363, 368, 469 N.E.2d 1067 (1984). If the taxpayer owns and operates two distinct businesses located in different states, the taxpayer can account separately for the income of each business and accurately allocate income to the taxing states. However, where a corporate taxpayer conducts a single, functionally integrated business in several states, i.e., a unitary business, separate accounting will likely be insufficient to apportion income among the various taxing states. Thus, many states, including Illinois, have developed formulas for apportioning income to their state from unitary businesses. Citizens Utilities Co. v. Department of Revenue, 111 Ill. 2d 32, 39-40, 488 N.E.2d 984 (1986); General Telephone Co., 103 Ill. 2d at 369; 35 ILCS 5/304(a) (West 1996).

A corporate taxpayer may also be a member of a unitary business group--"a closely associated group of corporations that collectively engages in a multistate unitary business". General Telephone Co., 103 Ill. 2d at 371. Where a part of the group's business is conducted in Illinois, a "combined apportionment" method is used to determine the business income attributable to this state by any member of the group. General Telephone Co., 103 Ill. 2d at 370-71; 35 ILCS 5/304(e) (West 1996). Borden does not challenge the methodology for apportioning income. Rather, Borden appeals the Director's determination that the Pepsi Subs were part of Borden's unitary business group for tax years 1981 and 1982.

Generally, whether a taxpayer participated in a unitary business group is a question of fact for the Department to determine, which will not be reversed on review unless against the manifest weight of the evidence. Citizens Utilities Co., 111 Ill. 2d at 47. Here, however, the facts were not in dispute. The case proceeded before the ALJ upon 93 stipulated facts and 41 joint exhibits. The legal effect to be given to these undisputed facts is a matter of law (American National Bank & Trust Co. v. Department of Revenue, 242 Ill. App. 3d 716, 721, 611 N.E.2d 32 (1993)), and this court is not bound by the agency's or the circuit court's legal Conclusions (Obasi v. Department of Professional Regulation, 266 Ill. App. 3d 693, 699, 639 N.E.2d 1318 (1994); Kroger Co. v. Department of Revenue, 284 Ill. App. 3d 473, 482, 673 N.E.2d 710 (1996)). Under such circumstances, the proper standard of review is not the manifest weight of the evidence test, but whether the agency's decision is arbitrary, unreasonable and not supported by sufficient evidence. Obasi, 266 Ill. App. 3d at 699. With respect to tax year 1981, no statutory definition of "unitary business group" had yet been adopted by our legislature. However, combined apportionment was required for such groups. Caterpillar Tractor Co. v. Lenckos, 84 Ill. 2d 102, 417 N.E.2d 1343 (1981). In Caterpillar Tractor Co., our supreme court described a unitary business as follows:

"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." Caterpillar Tractor Co., 84 Ill. 2d at 108.

The Department also promulgated a regulation, effective December 29, 1981, which describes a "unitary business" as follows:

"A trade or business carried on by more than one person is unitary in nature when the persons are related through common ownership and when the trade or business activities of each of the persons are integrated with, dependent upon, or contribute to the activities of one or more of the other persons." 6 Ill. Reg. 579 (now 86 Ill. Adm. Code §100.3010 c)1) (1996)).

The regulation also lists three factors, the presence of any one of which creates a strong indication that the activities of the taxpayers constitute a unitary business: (1) when all of the activities are in the same general line; (2) when the activities are steps in a vertical process; and (3) when there is a strong central management. 86 Ill. Adm. Code §100.3010 c)1)A),B),C) (1996).

The Department's definition of unitary business is similar, but not identical, to the statutory definition which became effective December 15, 1982, for tax years ending on or after December 31, 1982 (see P.A. 82-1029). The statutory definition reads in relevant 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 normally 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, ...

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