The opinion of the court was delivered by: Jeanne E. Scott United States District Judge
JEANNE E. SCOTT, U.S. District Judge
This matter is before the Court on Defendant Honeywell International, Inc.'s Motion to Dismiss (d/e 5) (Motion to Dismiss). According to the Complaint (d/e 1), Honeywell International, Inc. (Honeywell) benefitted from service transactions performed on its behalf in Illinois by General Electric Company (GE) and its predecessors-in-interest. The Complaint further alleges that Honeywell failed to pay the proper amount of tax on the transactions. GE seeks to recover from Honeywell $5,384,002.00 that GE paid to the Illinois Department of Revenue (Department) to settle tax deficiency claims relating to the relevant transactions. Honeywell has filed a Motion to Dismiss, asserting that GE fails to state a claim. GE is a New York corporation with its principal place of business in New York. Honeywell is a Delaware corporation with its principal place of business in New Jersey.*fn1 The amount in controversy exceeds $75,000.00; thus, this Court has jurisdiction pursuant to 28 U.S.C. § 1332. For the reasons set forth below, the Motion to Dismiss is allowed, in part, and denied, in part.
The following facts are taken from the allegations of the Complaint. Garrett Aviation, originally known as AirResearch Aviation, has provided services for corporate and general aviation customers since at least 1946. These services include airframe and engine inspections, maintenance and repair, avionics installations, and interior modifications. Since 1976, Garrett Aviation has operated a facility in Springfield, Illinois.
Prior to May 26, 1994, Honeywell owned and operated Garrett Aviation, including the Springfield, Illinois facility. At that time, Honeywell was in the business of manufacturing and servicing certain aircraft engines.
Among other things, Garrett Aviation's Springfield facility performed required periodic inspections, maintenance, repair and overhaul services (engine services) on Honeywell engines. During the time that Honeywell owned and operated Garrett Aviation, Honeywell performed engine services on Honeywell engines on an "as needed" time and material basis, or under maintenance agreements, known as Maintenance Service Plan Agreements (MSP Agreements). Under the MSP Agreements, the owner or operator of a Honeywell engine paid Honeywell a specific dollar amount for each hour of engine operating time. In exchange, Honeywell provided a defined set of inspections, maintenance, and repair services on the engines (MSP Services) and provided parts associated with the services at no extra charge to the owner/operator. During the time that Honeywell owned Garrett Aviation, Honeywell provided MSP Services to MSP Agreement customers through Garrett Aviation.
On May 26, 1994, Honeywell sold Garrett Aviation to a wholly-owned subsidiary of CFC Aviation Services, L.P. (CFC). In connection with the sale, Honeywell and CFC entered into an Operating Agreement, dated June 30, 1994, (Operating Agreement) which authorized Garrett Aviation to perform engine services on Honeywell engines and set out the terms under which such work would be performed. Honeywell designated CFC as a provider of MSP and non-MSP services on Honeywell engines. After the Operating Agreement was executed, Honeywell no longer provided MSP services to its MSP Agreement customers directly, but rather relied on CFC and its successors-in-interest to do so. Between 1994 and 2004, Honeywell stationed an employee at Garrett Aviation's Springfield facility to oversee and coordinate the provision of MSP services to Honeywell customers.
In May 1996, CFC sold Garrett Aviation to a wholly-owned subsidiary of UNC, Inc. In connection with this sale, all of CFC's rights and obligations under the Operating Agreement, absent certain immaterial exceptions, were assigned to UNC.
In September 1997, Garrett Aviation was purchased by a wholly-owned subsidiary of GE. According to the Complaint, incident to the purchase, GE acquired all of UNC's rights and obligations under the Operating Agreement. The Complaint further alleges that GE assumed certain "provisional liabilities of CFC and UNC related to the Garrett Aviation business," including the tax at issue in this lawsuit. Complaint, ¶ 15. On August 27, 2004, GE sold Garrett Aviation to an affiliate of The Carlyle Group. According to the Complaint, Garrett Aviation continued to provide MSP and non-MSP services for Honeywell engines through the date that the Complaint was filed.
Since July 1994, Garrett Aviation has invoiced for MSP transactions differently than for non-MSP transactions. For MSP transactions, Garrett Aviation invoiced Honeywell according to a formula set out in the Operating Agreement. For non-MSP transactions, Garrett Aviation invoiced the end user of the engine directly for time and material. Also since July 1994, Honeywell has supplied Garrett Aviation with a consigned inventory of parts that Garrett Aviation uses in performing services on Honeywell engines. A portion of the consigned inventory was housed at the Springfield facility.
When a consigned part was used in performing MSP services, invoicing occurred between Honeywell and Garrett Aviation. Honeywell would invoice Garrett Aviation for the part at the time it was removed from the consigned inventory. Garrett Aviation then invoiced Honeywell for the part at the time it invoiced Honeywell for the MSP services that were performed. When a consigned part was used in connection with non-MSP services, Honeywell generally invoiced Garrett Aviation for the part at the time it was removed from the consigned inventory, and Garrett Aviation then invoiced its customer for the part at the time it invoiced for the nonMSP services.
Illinois does not tax services, but the State does impose a Service Occupation Tax, or SOT, on the retail selling price of tangible personal property transferred incident to the sale of services. See 35 ILCS § 115/3. This tax is imposed upon "all persons engaged in the business of making sales of service (referred to as 'servicemen')." Id. The Service Occupation Tax "shall be paid to the Department by any serviceman transferring tangible personal property as an incident to a sale of service taxable under this [Service Occupation Tax] Act." 35 ILCS § 115/3-40.
Illinois also imposes a Service Use Tax, or SUT, "upon the privilege of using in this State real or tangible personal property acquired as an incident to the purchase of a service from a serviceman." 35 ILCS § 110/3. The Service Use Tax is imposed on the users of the property acquired incident to the purchase of services. Id. Under 35 ILCS § 110/3-40, the Service Use Tax: shall be collected at the time of purchase in the manner prescribed by the Department from the user by a serviceman maintaining a place of business in this State or by a serviceman authorized by the Department under Section 7 of this Act, and the tax shall be remitted to the Department as provided in Section 9 of this Act.
The tax imposed by this Act that is not paid to a serviceman under this Section shall be paid to the Department directly by any person using the property within this State as provided in Section 10 of this Act.
Thus, a serviceman is required to collect the Service Use Tax from his customer and remit it to the Department. However, the serviceman may retain the collected Service Use Tax if he has already paid Service Occupation Tax for the transaction to the Department. 35 ILCS § 110/8.
According to the Complaint, in non-MSP transactions, Garrett incurred and paid Service Occupation Tax to the Department and collected the corresponding Service Use Tax from the end user customer. The Complaint alleges that, in MSP transactions, the parties intended for Honeywell to pay the applicable tax directly to the Department. GE alleges that Honeywell provided Garrett with Exemption Certificates to memorialize this intent. According to the Complaint:
The first Exemption Certificate, dated February 27, 1998, applied to the period February 28, 1998 through May 4, 2000. The second Exemption Certificate, dated May 4, 2000, applied to the period May 5, 2000 to the present. In a letter to Garrett Aviation dated August 12, 2002, which Honeywell asked Garrett to accept in lieu of an Exemption Certificate, Honeywell represented that for the period July 1, 1994 through February 28, 1998, MSP Transactions were treated by Honeywell and Garrett Aviation in the same manner as MSP Transactions covered by the February 27, 1998 Exemption Certificate. Complaint, ¶ 40. Copies of the August 12, 2002. letter and the two Exemption Certificates are attached to the Complaint as exhibits. See Complaint, Exs. 1a, 1b, & 1c. Each Exemption Certificate provides that it will be a part of each order which Honeywell would place after the Certificate's issuance. The Certificates state that AlliedSignal or Honeywell "is directly paying the tax," and describe the products to be purchased as "spare parts and repair and overhaul services for GAS turbine engines." Complaint, Exs. 1a & 1b. The August 12, 2002, letter states in total:
Because it is against company policy to backdate any documents, I cannot issue an exemption certificate covering the period of June 1, 1996 through February 28, 1998. However, business transactions between Honeywell International (previously known as AlliedSignal, Inc.) and Garrett Aviation during the above time period, were the same for the period of the attached exemption certificate (dated February 27, 1998).
If you have any questions, please don't hesitate to give me a call. Complaint, Ex. 1c. GE alleges that despite these representations that Honeywell would pay the tax directly to the proper taxing authority, Honeywell failed to pay the correct amount of tax for the MSP transactions.
On December 29, 2000, the Department issued a Notice of Tax Liability to Garrett Aviation, seeking $3,727,783.00 in occupation tax, $39,454.00 in use tax, a late payment penalty of $573,471.00, and interest in the amount of $1,743,258.00 for an initial audit period of July 1, 1994 to May 31, 1996. General Electric Company's Memorandum of Law in Opposition to Defendant's Motion to Dismiss (d/e 9) (Memorandum in Opposition), Ex. 5, Notice of Tax Liability, dated December 29, 2000.*fn2 According to the Complaint, the amounts set out in the Notice of Tax Liability included approximately $2,500,000.00 in additional Service Occupation Tax and interest based on transfers of consigned parts in MSP service transactions for the initial audit period. Complaint, ¶ 51. The Department asserted that Garrett Aviation should have paid Service Occupation Tax on the value of consigned parts used in connection with the performance of MSP Services. The Department deemed that Garrett Aviation had purchased the parts from Honeywell and then resold them to Honeywell in connection with the performance of MSP services. Id., ¶ 52.
In February 2001, GE, on behalf of Garrett Aviation, filed a Protest and Request for Hearing in response to the Notice of Tax Liability. A Department Administrative Law Judge (ALJ) upheld the Notice in May 2003. The Department's Director accepted the ALJ's recommendation on June 13, 2003. In July 2003, GE appealed this decision to the Illinois Circuit Court.
By letter dated October 31, 2003, GE notified Honeywell of the Department's initial tax assessment, informing Honeywell that GE was challenging the assessment, but if its challenge did not succeed, GE would bill Honeywell for the taxes, interest, and penalties. The letter further informed Honeywell that the Department was conducting an audit relating to sales and use tax for the tax period from June 1, 1996, to December 31, 2001. The letter outlined an Illinois tax amnesty program that would apply and asked Honeywell to inform GE whether it wished Garrett Aviation to make payment under amnesty on its behalf. By letter dated November 7, 2003, Honeywell denied liability for "any Illinois sales or use taxes, interest, and penalties that have been or may in the future be assessed against Garrett Aviation Services." Complaint, Ex. 3, November 7, 2003, Letter from Paul H. Brownstein to Ramon Nunez.
The Department subsequently concluded audits for the tax periods June 1, 1996, to December 31, 2001, and January 1, 2002, through September 30, 2004. The Department informed GE that it intended to issue Notices of Proposed Tax Liability for these periods in an amount not less than $15,130,000.00, plus interest in the amount of $4,960,000.00 and penalties of $3,260,000.00. GE entered into settlement negotiations with the Department regarding its pending appeal and the amounts from the subsequent audits. In November 2004, GE and the Department reached a proposed ...