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182 Ill.2d 262

April 15, 1998

TEXACO-CITIES SERVICE PIPELINE COMPANY, APPELLANT,V. SAM MCGAW, ACTING DIRECTOR OF REVENUE, APPELLEE.


The opinion of the court was delivered by: Chief Justice Freeman

Agenda 8

January 1998.

delivered the opinion of the court:

Plaintiff, Texaco-Cities Service Pipeline (Texaco-Cities), brought an action for administrative review in the circuit court of Cook County against defendant, the acting director of the Illinois Department of Revenue (Department). Texaco-Cities sought review of the Department's determination that (1) proceeds from the sale of a pipeline and associated assets constituted "business income" under the Illinois Income Tax Act (Act) (35 ILCS 5/101 et seq. (West 1994)), and (2) the income was apportionable under the single-factor, "barrel miles" formula of section 304(d)(2) of the Act (35 ILCS 5/304(d)(2) (West 1994)). The circuit court affirmed the Department's classification of the sale proceeds as business income, but agreed with Texaco-Cities that the gain from the sale had been improperly apportioned. Both parties appealed. The appellate court affirmed the circuit court with respect to the classification issue. 286 Ill. App. 3d 529. The court disagreed with the apportionment determination, however, and as a result, reinstated the Department's original apportionment of the sale proceeds. We granted Texaco-Cities' petition for leave to appeal (166 Ill. 2d R. 315), and now affirm the appellate court.

BACKGROUND

Texaco-Cities, a Delaware corporation with its principal offices in Houston, Texas, is in the business of transporting crude oil and other petroleum products by pipeline. As part of its business, Texaco-Cities owned and operated pipelines which ran through several states, including Illinois. During the 1983 tax year, Texaco-Cities sold major segments of its pipeline assets and associated real estate, including its entire contingent of pipeline assets in Illinois. Prior to the sale, the pipelines sold had serviced the Texaco refinery in Lockport, Illinois, and the Cities Service, East Chicago refinery. However, these refineries subsequently ceased operations, idling the pipelines and rendering them of little operational value to Texaco-Cities. Thus, Texaco-Cities sold them to other companies with a refinery presence in the Chicago area. Texaco-Cities realized a gain from the sale of $9,987,176. The sale resulted in a nearly 90% reduction of Texaco-Cities' total pipeline miles.

On its return for the tax year 1983, Texaco-Cities reported the income from the sale as nonbusiness income, and allocated to Illinois $2,807,995 of the total gain, based upon the ratio of pipeline assets sold in this state to those sold everywhere. Texaco-Cities' remaining income was reported as business income, and apportioned as such under section 304(d)(2) of the Act.

The Department audited Texaco-Cities' tax returns for the tax year in question and, based upon the audit, assessed a deficiency against Texaco-Cities in the amount of $208,441. First, the Department reclassified the gain from the sale of the pipeline assets as "business income" subject to apportionment, finding that the sale constituted an "integral part of [Texaco-Cities'] trade or business operations" under the Act. Then, the Department apportioned Texaco-Cities' base income, including the gain from the sale, by the single-factor "barrel miles" formula articulated in section 304(d)(2) of the Act. Texaco-Cities filed a protest to the Department's decision, and the case was presented to an administrative law Judge. The matter proceeded for a hearing on a stipulation of the facts set forth above, and upon the following stipulated issues: (1) whether the gain from the sale of pipeline assets constituted business income; and (2) if so, whether it was properly subject to apportionment under section 304(d)(2) of the Act, as "business income derived from transportation by pipeline." 35 ILCS 5/304(d)(2) (West 1994).

In the administrative proceedings, Texaco-Cities disputed that the sale proceeds were business income, asserting that its business did not consist of disposing of large quantities of its pipeline assets. Instead, Texaco-Cities maintained, the sale was an extraordinary event and more in the nature of a cessation than a furtherance of business. Texaco-Cities further contended that the Department had improperly apportioned the sale proceeds under the barrel miles formula of section 304(d)(2), because that section encompassed only income derived "from transportation by pipeline." Rather, Texaco-Cities claimed that the income should have been apportioned under the standard three-factor formula in section 304(a) (35 ILCS 5/304(a) (West 1994)).

The administrative law Judge issued a recommended Disposition upholding the determination of the Department, and the Disposition was accepted by the Department. In its complaint for administrative review, Texaco-Cities renewed its contentions in the administrative proceedings, and also argued that the apportionment under the barrel miles formula resulted in a deprivation of its due process rights under the United States Constitution.

The circuit court issued a memorandum decision and judgment affirming the Department's characterization of the income as business income. However, the court agreed with Texaco-Cities that the gain was improperly apportioned under the barrel miles formula and that it should have been apportioned under the three-factor formula of section 304(a). The court made the additional finding that apportionment under the barrel miles formula would amount to a deprivation of Texaco-Cities' due process rights.

On appeal, the appellate court affirmed the finding that the gain was business income. However, the court reversed the circuit court's apportionment of the gain under the three-factor formula and reinstated the Department's application of the single factor apportionment. The court declined to reach the question of whether apportionment under section 304(d)(2) amounted to a violation of due process, finding that Texaco-Cities had waived the issue by failing to raise it in the first instance in the administrative proceedings. 286 Ill. App. 3d 529.

ANALYSIS

I. Classification as Business Income

Texaco-Cities first challenges the Department's determination that the gain from the sale of its pipeline assets constituted business income. Section 1501(a)(1) of the Act defines "business income" as:

"income arising from transactions and activity in the regular course of the taxpayer's trade or business ***, and includes income from tangible and intangible property if the acquisition, management, and Disposition of the property constitute integral parts of the taxpayer's regular trade or business operations." 35 ILCS 5/1501(a)(1) (West 1994).

Conversely, "nonbusiness income" is defined as all income other than business income. 35 ILCS 5/1501(a)(13) (West 1994). In general, nonbusiness income from tangible property is allocated to the state that is the situs of the property based upon the application of statutory factors. Business income, on the other hand, is apportioned among states based upon their respective "contribution to the environment that permitted the corporation to earn an income." 1 Ill. Tax Reporter, par. 12-004, at 1473 (1987). An entity claiming that its income is nonbusiness income bears the burden of clearly proving this fact. See generally Canteen Corp. v. Department of Revenue, 123 Ill. 2d 95, 106-07 (1988); National Realty & Investment Co. v. Department of Revenue, 144 Ill. App. 3d 541 (1986).

The definition of business income in section 1501(a)(1) is virtually identical to that established in section 1(e) of the Uniform Division of Income for Tax Purposes Act (UDITPA), from which our act was derived. The UDITPA was subsequently adopted as article IV of the Multistate Tax Compact (MTC) (Asarco Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 310 n.3, 73 L. Ed. 2d 787, 791 n.3, 102 S. Ct. 3103, 3106 n.3 (1982)), and to the extent the language of our act parallels that of the MTC, we may examine the policies underlying the MTC and the UDITPA in arriving at the meaning of our act. See Caterpillar Tractor Co. v. Lenckos, 84 Ill. 2d 102, 121 (1981). States adopting the UDITPA have recognized that the language of section 1501(a)(1) encompasses two tests for determining whether income from the Disposition of capital assets constitutes business income: the "transactional" test, embodied in the first clause of the definition, and the "functional" test, contained in the second clause. See, e.g., Ross-Araco v. Commonwealth of Pennsylvania, Board of Finance & Revenue, 544 Pa. 74, 674 A.2d 691 (1996); District of Columbia v. Pierce Associates, Inc., 462 A.2d 1129 (D.C. 1983). Income is business income under the transactional test if it is "attributable to a type of business transaction in which taxpayer regularly engages." National Realty, 144 Ill. App. 3d at 554. More broadly, under the functional test, all gain from the Disposition of a capital asset is considered business income if the asset disposed of was "used by the taxpayer in its regular trade or business operations." National Realty, 144 Ill. App. 3d at 554; see also Ross-Araco, 554 Pa. 74, 674 A.2d 691 (if asset produced business income while it was owned by the taxpayer); Laurel Pipe Line Co. v. Commonwealth of Pennsylvania, Board of Finance & Revenue, 537 Pa. 205, 642 A.2d 472 (1994); Pierce, 462 A.2d 1129. The frequency and regularity of the transaction at issue are central considerations in applying the transactional test. Under the functional test, however, the extraordinary nature or infrequency of the sale is irrelevant. Ross-Araco, 544 Pa. at 79, 674 A.2d at 693. The income constitutes business income if either one of the above tests is met. National Realty, 144 Ill. App. 3d at 554; see Ross-Araco, 544 Pa. at 79, 674 A.2d at 693; Pierce, 462 A.2d at 1131 (two clauses set forth independent, alternative tests).

The parties agree that the resolution of this case turns upon an interpretation of the latter clause of section 1501(a)(1), addressed to income from tangible and intangible assets. The Department conceded that the sale of Texaco-Cities' pipeline did not fall under the transactional test. Thus, we focus our analysis upon the ...


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