Appeal from the Circuit Court of Cook County No. 97 L 50872 Honorable Joanne L. Lanigan, Judge Presiding.
The opinion of the court was delivered by: Justice McBRIDE
This appeal arises from an administrative review action filed by plaintiff-appellant/cross-appellee, PPG Industries, Inc. (PPG or Taxpayer). Taxpayer is a Pennsylvania corporation with its principal place of business in Pittsburgh, Pennsylvania. Defendant-appellee/cross-appellant is the Department of Revenue of the State of Illinois (Department). Taxpayer appeals the trial court's decision which upheld the Department's finding that Taxpayer was liable for tax penalties for the tax years 1987, 1988, 1989, and 1990. PPG timely filed a notice of appeal on July 12, 1999, seeking only a reversal of the trial court's imposition of penalties based upon the claim that it exercised ordinary business care in determining, filing, and paying its proper tax liability. On July 22, 1999, the Department cross-appealed the trial court's order which held that the Department's decision concerning throwback or reversionary sales was against the manifest weight of the evidence.
In order to review the propriety of penalties imposed against PPG, we must determine whether PPG exercised ordinary business care in measuring its tax liability. To make that determination, we must, in turn, examine five issues: (1) whether PPG and its subsidiary, PPG Oil and Gas, Inc. (Oil & Gas) were a unitary business group; (2) whether the gain PPG realized from the sale of Oil & Gas's assets was business income apportionable to Illinois; (3) whether royalty income PPG received from intellectual property licensing agreements to foreign entities was business income apportionable to Illinois; (4) whether the Department improperly threw back the sales of certain PPG subsidiaries to Illinois; and (5) whether penalties imposed on PPG for underpaying taxes for the 1987, 1988, 1989, and 1990 tax years under section 1005(a) of the Illinois Income Tax Act (Ill. Rev. Stat. 1991, ch. 120, par. 10-1005 (the Act). were properly calculated. *fn1 We review only those facts necessary for disposing of this appeal.
PPG is a global manufacturer and distributor of glass, fiberglass, coatings, and resins of chemicals. It is responsible for paying taxes on a calender year basis. The Department made two separate audits on PPG for the periods 1987-88 and 1989-90 respectively. Based on these audits, the Department issued notices of deficiency against PPG for tax infractions occurring between 1987 and 1990. PPG timely protested the deficiency notices. The notices of deficiency and corresponding protests were consolidated for an administrative hearing. On May 23, 1997, the Department determined that Taxpayer owed an additional tax amount of $1,406,103 plus penalties in the amount of $785,011.11.
Oil & Gas as Part of PPG's Unitary Business Income
One of PPG's enterprises is the production of potash, which is a potassium carbonate substance derived from the ashes of wood. While exploring for potash in Michigan, PPG discovered deposits of oil and natural gas. Based on this discovery, PPG formed Oil & Gas to maintain the exploration and extraction of oil and natural gas in Michigan. In 1981, Oil & Gas was incorporated as a wholly owned subsidiary of PPG. All of the officers of Oil & Gas were officers or employees of PPG. Thomas Neider, a PPG employee, was the manager of PPG's agricultural and performance chemical division between 1981 and 1987. Neider was paid by PPG and oversaw potash production as well as the operation of Oil & Gas.
Neider was the supervisor of James Hafenbrack, who was hired by PPG from the Exxon Corporation to be general manager of Oil & Gas. The record discloses that Hafenbrack was a PPG employee, not an Oil & Gas employee. Regardless, he was charged with making day-to-day decisions concerning the operations of Oil & Gas such as where wells would be drilled and where lease and land rights could be acquired.
The record also reveals that PPG internally reported Oil & Gas financial information with the financial reports of its chemical division. Also, PPG provided all of the operating funds for Oil & Gas. In 1987, all expenses of Oil & Gas were paid by PPG and then billed to Oil & Gas through PPG's interoffice billing procedure. Many of the invoices regarding purchases made by Oil & Gas are in PPG's name.
The record indicates that PPG performed accounting, legal, and tax services for Oil & Gas. Further, PPG entered into all contracts to sell the products produced by Oil & Gas. Also, in 1994, the Stony Point natural gas plant was constructed by Oil & Gas in Michigan. The record indicates that PPG invested a significant amount in the financing and construction of the Stony Point refinery.
In 1987, all of the assets of Oil & Gas were sold to Marathon Oil Company. PPG planned, negotiated, and executed the contract to sell Oil & Gas. Throughout the years when Oil & Gas operated, PPG reported in its annual reports that oil and gas production was part of its chemical processing business.
Gain on the Sale of Oil & Gas Assets
In its 1987 Illinois tax return, PPG excluded Oil & Gas from its unitary business income, and thus excluded the gain on the sale of Oil & Gas' assets to Marathon Oil Company. Based on the 1987-88 audit, the Department included the gain on the sale of Oil & Gas' assets as part of PPG's unitary business income. In addition, the Department imposed penalties on PPG for not reporting the gain as Illinois business income.
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During the two audit periods, James Zamboldi, PPG's supervisor of state income taxes, was the contact person with the auditors. During these audits, the record reveals that the auditors made written inquiries to PPG to provide data showing sales by origin and destination. Zamboldi informed the auditors that PPG did not generate documents which indicated sales by origin. He further said that the only way PPG could comply with the request was through original invoices, which were maintained on microfiche at PPG's headquarters in Pittsburgh, Pennsylvania, and at other sites throughout the country.
Zamboldi said that neither auditor asked him to generate the invoices from the microfiche. Also, Zamboldi did not tender any invoices to the auditors. George Getty, PPG's tax attorney, testified that PPG maintained records that would reflect sales made by destination. Getty also stated that these documents existed during the audit period and that Zamboldi could have obtained them.
Because the auditors could not acquire the origin and destination sales information they sought, the Department calculated PPG's throwback sales attributable to Illinois by using a formula. The formula's ratio was based on PPG's average Illinois inventory to PPG's average inventory "everywhere" (or worldwide) and was applied against total sales everywhere (or worldwide).
On May 23, 1997, the Department affirmed the notices of deficiency against PPG. Specifically, it found, for the audit periods at issue: (1) that PPG and Oil & Gas were a unitary business group; (2) that the gain PPG realized from the sale of Oil & Gas was business income apportionable to Illinois; (3) that royalty income PPG received from intellectual property licensing agreements to foreign entities was business income apportionable to Illinois; (4) that the Department properly threw back the sales of certain PPG subsidiaries to Illinois; and (5) that PPG was liable for penalties for underpaying taxes for the 1987, 1988, 1989, and 1990 tax years.
As noted above, on August 12, 1997, PPG sought administrative review in the trial court. The trial court affirmed all of the Department's findings except on the question of reversionary or throwback sales. In regard to throwback sales, the trial court concluded that the auditors had ignored the sales invoices which, in fact, existed and therefore had not conducted a minimally reasonable audit. Since the method of calculation lacked accuracy, the trial court held that the Department's assessment of throwback sales was against the manifest weight of the evidence. Thus, the trial court entered a judgment against PPG in the amount of $3,379,720 which included $785,011 in penalties. As also stated above, PPG appealed on July 12, 1999, seeking only a reversal of the trial court's imposition of penalties. In response, the Department cross-appealed the trial court's order which reversed the Department's decision on the question of throwback sales.
We apply a manifest weight of the evidence standard of review to the first, second, and third questions on appeal. "The existence of reasonable cause justifying abatement of a [tax] penalty is a factual determination that will be decided only on a case-by-case basis. [Citation.]" Kroger Co. v. Department of Revenue, 284 Ill. App. 3d 473, 484, 673 N.E.2d 710 (1996). Where the questions to be decided are factual questions, our supreme court has stated that:"[O]n administrative review, it is not a court's function to reweigh the evidence or make an independent determination of the facts. Rather, the court's function is to ascertain whether the findings and decision of the agency are against the manifest weight of the evidence. [Citations.] An administrative agency decision is against the manifest weight of the evidence only if the opposite conclusion is clearly evident." Abrahamson v. Illinois Department of Professional Regulation, 153 Ill. 2d 76, 88, 606 N.E.2d 1111 (1992).
With the appropriate standard in place, we examine the arguments made by the parties concerning the first three questions on appeal.
Taxpayer's argument on the first question is that, under the law at the time the audit was conducted, it had reasonable cause to exclude Oil & Gas from its unitary business group. When Taxpayer filed its tax returns for the years 1987 through 1990, section 1005(a) of the Act provided:
"If any amount of tax required to be shown on a return prescribed by this Act is not paid on or before the date required for filing such return (determined without regard to any extension of time to file), a penalty shall be imposed at the rate of 6% per annum upon the tax underpayment unless it is shown that such failure is due to reasonable cause. This penalty shall be in addition to any other penalty determined under this Act." Ill. Rev. Stat. 1991, ch. 120, par. 10-1005.
The trial judge noted that "reasonable cause," stated above, was not defined in the Act at the time Taxpayer filed its returns for the audit period at issue. We determine, however, that at least one appellate decision existed at the time Taxpayer's returns were due where reasonable cause was interpreted to mean the exercise of ordinary care and business prudence. Du Mont Ventilation Co. v. Department of Revenue, 99 Ill. App. 3d 263, 266, 425 N.E.2d 606 (1981), cited in, Kroger Co., v. Department of Revenue, 284 Ill. App. 3d 473, 484, 673 N.E.2d 710 (1996).
Section 1005 (a) was amended, effective January 1, 1993, omitting the "reasonable cause" language and referring to the Uniform Penalty and Interest Act (35 ILCS 735/3-1 et seq. (West 1994)), which currently contains such language. 35 ILCS 735/3-8 (West 1994). Regulation section 700.400 (c) of the Illinois Administrative Code, which was adopted under the Uniform Penalty and Interest Act and became effective January 13, 1994, provides the following:
"A taxpayer will be considered to have made good faith effort to determine and file and pay his proper tax liability if he exercised ordinary business care and prudence in doing so. A determination of whether a taxpayer exercised ordinary business care and prudence is dependent upon the clarity of the law or its interpretation and the taxpayer's experience, knowledge and education." 86 Ill. Adm. Code §700.400(c) (1998).
Further, this court has held that "[r]easonable cause generally has been interpreted to mean the exercise of ordinary business care. [Citation.]" Kroger, 284 Ill. App 3d at 484, 673 N.E.2d 710 (1996); Peoria & Pekin Union Ry. Co. v. Department of Revenue, 301 Ill. App. 3d 736, 744, 704 ...