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Hormel Foods Corporation v. Zehnder

September 29, 2000

HORMEL FOODS CORPORATION AND JENNIE-O-FOODS, INC., PLAINTIFFS-APPELLANTS,
v.
KENNETH E. ZEHNDER, DIRECTOR OF THE DEPARTMENT OF REVENUE, AND THE DEPART-MENT OF REVENUE, DEFENDANTS-APPELLEES.



Appeal from the Circuit Court of Cook County No. 98 L 50151 The Honorable Joanne L. Lanigan, Presiding Judge.

The opinion of the court was delivered by: Justice Buckley

Plaintiffs Hormel Foods Corporation and one of its subsidi-aries, Jennie-O Foods, Inc. (collectively Taxpayers), appeal 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 1998))), Taxpayers were members of a "unitary business group" for the years 1991, 1992, and 1993, as defined in section 1501(a)(27) of the Tax Act (35 ILCS 5/1501(a)(27) (West 1998)) and issued notices of deficiency against Hormel in the amount of $101,191 and Jennie-O in the amount of $214,210. We affirm.

BACKGROUND

Hormel is an Austin, Minnesota-based meat processor and manufacturer of food products. Hormel has acquired several subsidiary companies, all of which are somehow related to the food business. Hormel classifies its subsidiaries as either "core" subsidiaries or "stand-alone" subsidiaries. The core subsidiaries are operated as divisions of Hormel and are not run as separate companies. During the tax years at issue, the core companies were Dubuque Foods, Logistice Services, Inc., Creative Contract Packaging (CCP), Rochelle Fresh Meats, Rochelle Processed Meats, Rochelle Foods, and Dold Foods. During the tax years at issue, the stand-alone companies were Jennie-O, Catalogue Marketing, Hormel International, Vista, Farm Fresh Catfish, Algona Food Equipment Co., Inc., Dan's Prize, Inc., and Dubuque/FDL Marketing.

Hormel filed a separate Illinois corporate income tax return for the tax year ending October 31, 1991. Hormel filed a combined Illinois return with CCP (one of Hormel's core subsidiaries) for the tax year ending October 31, 1992. Hormel filed a combined Illinois return with CCP and Dubuque (also a core subsidiary) for the tax year ending October 31, 1993. Vista (a stand-alone subsidiary) filed separate Illinois corporate income tax returns for tax years ending October 31, 1991 through October 31, 1993.

After an audit, the Director issued notices of deficiency to Hormel and Jennie-O for $101,919 and 214,210, respectively, and a notice of overpayment of $28,293 to Vista on January 31, 1996. Hormel and Jennie-O protested the notices and asserted that they were not a unitary business group for purposes of the Tax Act.

After a hearing, the administrative law judge (ALJ) found that "Hormel and all of its subsidiaries are functionally integrated through the exercise of strong centralized management, and therefore constitute a unitary business group pursuant to 35 ILCS 5/1501(a)(27)." As such they were required to file combined Illinois corporate tax returns. The ALJ's finding was based in part upon the existence of a flow of knowledge and a flow of value between Hormel and its subsidiaries, in addition to the centrali-zation of a number of corporate services at Hormel. The Director adopted the ALJ's finding. Thereafter, Taxpayers sought admini-strative review in the Cook County circuit court. The circuit court affirmed the ALJ's ruling and Taxpayers now appeal.

The issue before us is whether Hormel and its subsidiaries comprise a unitary business group as defined in section 1501(a)(27) of the Illinois Income Tax Act.

ANALYSIS

I. Overview

Under the due process and commerce clauses of the United States Constitution, a state may tax income earned only within its borders. See Container Corporation of America v. Franchise Tax Board, 463 U.S. 159, 77 L. Ed. 2d 545, 103 S. Ct. 2933 (1983). A thorough review of the principles of income apportionment for state income taxation purposes can be found in our supreme court's opinion General Telephone Co. v. Johnson, 103 Ill. 2d 363, 368-72 (1984). We will very briefly reiterate them here.

When a single-taxable entity owns and operates separate and distinct businesses in different states, the entity must determine and account for the amount of income that is attributable to the operations in each taxing state. In such a case, because each operation is separate and distinct, the entity can accurately determine income earned in each state by utilizing the "separate accounting" method. See General Telephone Co. v. Johnson, 103 Ill. 2d 363, 369 (1984); Citizens Utilities Co. v. Department of Revenue, 111 Ill. 2d 32, 39 (1986).

Somewhat more complicated is the case of a corporation that operates a single, functionally integrated business in more than one state (i.e., a unitary business where each operation contributes to the income of the business as a whole). In the case of a unitary business, the separate accounting method does not accurately divide the income among the various taxing states. See General Telephone, 103 Ill. 2d at 369; Citizens Utilities, 111 Ill. 2d at 39. So, to provide for a more exact accounting, many states, including Illinois, employ some variation of "formula apportion-ment." See General Telephone, 103 Ill. 2d at 370; Citizens Utilities, 111 Ill. 2d at 39; 35 ILCS 5/304(a) (West 1998). Under the formula apportionment method, the income of the taxable entity is totaled and apportioned to each taxing state based on the ratio that the entity's activities in the taxing state bear to the entity's activities in all the states. See General Telephone, 103 Ill. 2d at 370; Citizens Utilities, 111 Ill. 2d at 40.

An even more complicated situation exists in the case of a corporation that carries on a multistate unitary business as part of an associated group of corporations, commonly referred to as a "unitary business group." See General Telephone, 103 Ill. 2d at 371; Citizens Utilities, 111 Ill. 2d at 40. In the case of a unitary business group, Illinois uses the "combined apportionment" method to determine the income attributable to Illinois by any member of the group. See General Telephone, 103 Ill. 2d at 371; 35 ILCS 5/304(e)(West 1998). The combined apportionment method operates to treat the group of corporations as though it was a single-taxable entity carrying on a unitary business. See Citizens Utilities, 111 Ill. 2d at 40. Similar to formula apportionment, the combined apportionment method takes the total income of the unitary business (by combining the income from each corporation involved in the business) and applies an apportioning ratio to the total to determine the taxable income of the member operating in the taxing state. See General Telephone, 103 Ill. 2d at 371-72; Citizens Utilities, 111 Ill. 2d at 40.

Because there are constitutional limitations on a state's power to tax income that arises out of interstate activities, a state may tax out-of-state activities of an associated corporation by combined apportionment only when the corporations constitute a "unitary business." See Container Corp. v. Franchise Tax Board, 463 U.S. 159, 165-67, 77 L. Ed. 2d 545, 553-55, 103 S. Ct. 2933, 2940-41 (1983). Taxpayers in the case at bar appeal the determina-tion that they ...


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