The opinion of the court was delivered by: Justice O'mara Frossard
Appeal from the Circuit Court of Cook County
Honorable John A. Ward, Judge Presiding.
Plaintiff, Home Interiors & Gifts, Inc., appeals the order of the circuit court affirming the Department of Revenue's (Department) finding that plaintiff owes taxes on interest income it earned in 1989 and 1990. In 1993, the Department issued to plaintiff a notice of business income tax deficiency. The Department determined that plaintiff's corporate tax returns for the years of 1989 and 1990 should be adjusted to reflect certain interest income plaintiff earned from short-term investments in those years. Plaintiff filed a protest, and the parties submitted a stipulation of facts to an administrative law judge (ALJ). The ALJ recommended that plaintiff owed additional corporate taxes for the years of 1989 and 1990, finding that all the interest income from plaintiff's short-term investments constituted apportionable business income. The Director of the Department adopted this recommendation. Plaintiff then sought administrative review of the Director's decision. The circuit court affirmed the Director's decision. On appeal, plaintiff argues that imposition of the Illinois income tax on its entire interest income from its short-term investment accounts violates the due process clause and the commerce clause of the United States Constitution.
The parties stipulated to the following facts. Plaintiff is a Texas corporation that sells wholesale home decorative accessories nationwide. In 1989 and 1990, plaintiff generated sufficient cash to sustain its business operation and, as a result, had modest working capital requirements and no need to borrow funds from outside sources. Plaintiff invested its excess capital in long-term and short-term investments. During 1989 and 1990, plaintiff purposefully invested in short-term securities, because it was waiting for more favorable developments in long-term money markets and the Texas commercial real estate market.
Plaintiff maintained its short-term investments in five accounts: Coppell Bank, Small Bank, Municipal Bank, Bank One, and Salomon Brothers. Each account earned plaintiff interest income, and plaintiff reported these accounts as investments on its balance sheet. On both its Texas franchise returns and its Illinois corporate income taxes for years 1989 and 1990, plaintiff reported this interest income as allocable only to Texas. The Department acknowledged that the interest from the Salomon Brothers account was not apportionable, because this account was not designated or available as working capital and was never used in plaintiff's trade or business.
The parties stipulated the following about the funds in the four other short-term investment accounts: "the funds from these general accounts were utilized in part as working capital reserve. None of these funds were *** designated for a particular use, and all of the funds were available for use in the day to day business operations of the [plaintiff]."
In 1989 and 1990, the four investment accounts at issue generated interest income of $7,681,334 and $11,017,682. The Department sought to tax all this income as apportionable. Plaintiff claimed that only a portion of the income was apportionable. The parties then stipulated to the results of a formula created by plaintiff which calculated the greatest percent invasion into each account for each year to determine the amount of interest income that was attributable to its use of the funds and constituted business income. The Department agreed with the formula but objected to whether "any methodology can bifurcate an account to clearly reflect that portion is used in the business and generates business income and that portion is not used in the business and generates non-business income that is not apportionable." Applying plaintiff's formula, the parties stipulated that if only a portion of Home Interiors' income from its four investments is to be apportioned, the amounts of income to be apportioned are $1,912,652.17 in 1989 and $1,650,448.80 in 1990.
The ALJ found that plaintiff regularly invested its excess cash in short-term accounts and considered these accounts as working capital reserve. The ALJ also rejected plaintiff's formula for determining the amount of interest income that was apportionable. The ALJ believed that because plaintiff "admitted that these [short-term investment] funds were used for working capital," then all the interest income constituted business income apportionable to Illinois. The Director of the Department adopted the ALJ's decision that all of the interest income from Home Interiors' four investments is apportionable business income and the circuit court affirmed. The circuit court first found that plaintiff's entire interest income in the short-term accounts constituted business income under the Illinois Income Tax Act (35 ILCS 5/1501(a)(1) (West 1998)). The circuit court next rejected plaintiff's constitutional claim. The circuit court found that because plaintiff invested these funds in accounts "used for working capital" and that this undivided income was the source of "funds necessary for day-to-day operations," it had failed to meet its burden to establish that only a portion of the income was apportionable. The circuit court characterized plaintiff's formula as "conceptually flawed" and, like the ALJ, rejected it. This appeal followed.
On appeal, plaintiff only asserts its constitutional claim. Plaintiff argues that the due process and commerce clauses give Illinois the authority to tax only the interest income in the short-term investments accounts that plaintiff used as working capital. Therefore, according to plaintiff, only the income identified by its formula as being used as working capital is apportionable ($1,912,652.17 in 1989 and $1,650,448.80 in 1990). The Department counters that, because all the funds in the short-term investment accounts were available for plaintiff's business operations, all the income from these accounts is subject to the Illinois business income tax and is apportionable.
Under the Administrative Review Law (735 ILCS 5/3-101 et seq. (West 1998)), we review the final decision of the administrative agency and not the decision of the circuit court. Richard's Tire Co. v. Zehnder, 295 Ill. App. 3d 48, 56 (1998). While the reviewing court defers to the agency's findings of fact (735 ILCS 5/3-110 (West 1998)), it conducts an independent review of its conclusions of law. County of Cook v. Licensed Practical Nurses Ass'n of Illinois, Division I, 284 Ill. App. 3d 145, 152 (1996). When the agency decides a mixed question of law and fact, we review its decision under a clearly erroneous standard. City of Belvidere v. Illinois State Labor Relations Board, 181 Ill. 2d 191 (1998). When the issue on appeal is one of law only and involves no question of fact, we review the agency's decision de novo. Rockwood Holding Co. v. Department of Revenue, 312 Ill. App. 3d 1120, 1123 (2000).
Relying on City of Belvidere, the Department argues that we should apply the clearly erroneous standard. In City of Belvidere, the issue raised was whether the city's refusal to engage in collective bargaining constituted an unfair labor practice pursuant to the Illinois Public Labor Relations Act (Act) (5 ILCS 315/1 et seq. (West 1998)); City of Belvidere, 181 Ill. 2d at 202. The court found that the agency's decision required it to make both a factual determination of the city's practices and a legal interpretation of the Act. The court held that because the agency's decision involved a mixed question of law and fact, the clearly erroneous standard was the correct standard of review. City of Belvidere, 181 Ill. 2d at 205.
In this case, unlike City of Belvidere, the parties stipulated to the facts and have not asked us to review any factual findings. On appeal plaintiff challenges the constitutionality of apportioning all its interest income from these accounts. Thus, the only issue before us involves a question of law, namely, whether the United States Constitution prohibits the Department from apportioning interest income that plaintiff had available as working capital, but did not use as working capital. It is well settled that an administrative agency has no authority to declare a statute unconstitutional or even to question its validity. Texaco-Cities Service Pipeline Co. v. McGaw, 182 Ill. 2d 262, 278 (1998). Questions of law decided by an agency are not entitled to deference and are reviewed de novo. XL Disposal Corp. v. Zehnder, 304 Ill. App. 3d 202 (1999). The de novo standard of review applies to the constitutional issue of law raised by Home Interiors.
The issue is whether all the interest income from plaintiff's short-term investments constituted apportionable business income subject to Illinois tax. The United State Constitution requires that the taxpayer have "some minimum connection" with the taxing body and that the tax is "rationally related to 'values connected with the taxing [s]tate.' " Quill Corp. v. North Dakota, 504 U.S. 298, 306, 119 L. Ed. 2d 91, 102, 112 S. Ct. 1904, 1909-10 (1992), quoting Moorman Manufacturing Co. v. G.D. Bair, 437 U.S. 267, 273, 57 L. Ed. 2d 197, 204, 98 S. Ct. 2340, 2344 (1978). Thus, a state may not tax value outside its borders. Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 119 L. Ed. 2d 533, 112 S. Ct. 2251 (1992). The due process and commerce clauses of the United States Constitution require " 'some definite link, some minimum connection between a state and the *** transaction it seeks to tax.' " Quill Corp., 504 U.S. at 306, 119 L. Ed. 2d at 102, 112 S. Ct. at 1909, quoting Miller Brothers Co. v. Maryland, 347 U.S. 340, 344-45, 98 L. Ed. 744, 748, 74 S. Ct. 535, 539 (1954). A state may, however, tax the multistate income of a nondomiciliary corporation if a minimal connection exists between the corporation's activities and the taxing state and a rational relationship exists between "the income attributed to the taxing State and the intrastate value of the corporate business." Allied-Signal, Inc., 504 U.S. at 772, 119 L. Ed. 2d at 542, 112 S. Ct. at 2255.
To determine whether a state may apportion corporate income of a nondomiciliary corporation, the United State Supreme Court has applied the "unitary relationship" and "operational function" tests. Under the unitary relationship test, the payee and the payor of the dividend or other income have a unitary business relationship. More specifically, although a business may have subsidiaries, divisions, or common ownership of other businesses that operate in different jurisdictions, a single state may tax all the income earned and apportion it because the businesses have common managerial or operational resources that produce economies of scale and a substantial sharing of values. Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 179, 77 L. Ed. 2d 545, 562, 103 S. Ct. 2933, 2947 (1983). The Court has stated that " '[t]he linchpin of apportionability in the field of state income taxation is the unitary-business principle.' " ...