Record and brief — Chicago Bridge & Iron Co. v. Caterpillar Tractor Co.
Supreme Court brief1981
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— YUBWAIEIS
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Office Supreme Court, US.
8 l k IT LED
| 349 AUG 24 198!
No. ALEXAND -? L. STEVAS,
CLERK
IN THE
Supreme Court of the United States
Ocrosrr Tzrm, 1981
CHICAGO BRIDGE & IRON COMPANY,
Appellant,
v.
CATERPILLAR TRACTOR CO., ILLINOIS
DEPARTMENT OF REVENUE, et al,
Appellees.
——_————
—————
Appeal from the Supreme Court of Illinois
JURISDICTIONAL STATEMENT
Wu P. Surrer
One First National Plaza
Chicago, Illinois 60603
(312) 558-6616
Attorney for Appellant
Of Counsel:
Ricuarp BroMiey
One First National Plaza
Chicago, Illinois 60603
(312) 558-6614
i
QUESTIONS PRESENTED
This appeal presents the following questions under the
United States Constitution :
Does imposition of the Illinois income tax on the ap-
portioned combined worldwide business income of a
group of related corporations, including foreign cor-
porations, create a substantial risk of international
multiple taxation, and thus violate the Commerce
Clause?
Does imposition of the Illinois income tax on the ap-
portioned combined worldwide business income of a
group of related corporations, including foreign cor-
porations, prevent the Federal Government from speak-
ing with one voice when regulating commercial rela-
tions with foreign governments, and thus violate the
Commerce Clause?
Does imposition of the Illinois income tax on an Illi-
nois taxpayer, where the amount of its income subject
to tax is measured by reference to the income, prop-
erty, payroll and sales of all members of a group of
related corporations doing a worldwide business, vio-
late the Fourteenth Amendment requirements of due
process and equal protection of the laws?
PARTIES
Pursuant to Supreme Court Rules 12 and 15, the appel-
lant files this, its statement of the bases on which it con-
tends that the Supreme Court of the United States has
appellate jurisdiction to review on appeal the judgment
appealed from herein. The appellees are Caterpillar Tractor
Co., Caterpillar Americas Co., Caterpillar Credit Corp.,
Caterpillar Finance Corp., Caterpillar Machinery Corp.,
ii
Daniel J. Lenckos, Acting Director, and Illinois Depart-
ment of Revenue.'
1 Other parties to the proceeding in the Illinois Supreme Court
who have elected not to join in this appeal are The Coca-Cola Com-
pany, Coca-Cola Bottling Company of Chicago, Canners for Coca-
Cola Bottlers, Inc., C. B. Boiler Service, Inc., Universal Water
Softener Corp., Johns-Manville Products Corporation, Johns-Man-
ville Sales Corporation, Johns-Manville Service Corporation, Johns-
Manville Perlite Corporation, John Brand Corporation, National
Ceiling Systems Corporation, Deere & Company, E. R. Squibb &
Sons, Inc., Sears, Roebuck & Co. and International Harvester Com-
pany. The names of parent companies, subsidiaries (except wholly-
owned subsidiaries) and affiliates of appellant, as required by Rule
28.1, were listed in appellant’s Application for Extension of Time
for Docketing Appeal. Although Deere & Company filed a notice of
appeal in this case, it has chosen not to participate further and has
not joined in this jurisdictional statement.
iii
TABLE OF CONTENTS
Constitutional Provisions and Statute Involved ......
ee Or ee... iwi de oule Dadbmes ce
Reasons Why Questions Presented Are Substantial . . .
I. Combined Reporting Has Never Been Presented
I eETaC EN is so Se eb e tah heasewbawe ©
II. Worldwide Combined Reporting Creates a: Sub-
stantial Risk of International Multiple Taxation,
Thereby Violating the Commerce Clause ........
III. Combined Reporting Prevents the Federal Gov-
ernment From “Speaking With One Voice When
Regulating Commercial Relations with Foreign
Governments,” and Creates a Risk of Retaliation
by Foreign Governments, Thereby Violating the
COIN IID cir oo Ses bo Beldecogenulec os’
IV. Combined Reporting Imposes A Tax on One Cor-
poration Measured By the Income of Another and
Thereby Violates The Fourteenth Amendment’s
Requirements of Due Process and Equal Protec-
SU eG be ghRAGh SA's Beeen cc pcecesechawen case
a ee ake alt cae
12
18
iv
TABLE OF AUTHORITIES
Cases
Adams Express Co. v. Ohio State Auditor, 165 U.S.
194, 41 L.Ed. 683, 17 S.Ct. 305 (1896) .............
American Smelting ¢ Refining Co. v. Idaho State Taz
Commission, 99 Idaho 924, 592 P.2d 39 (1979),
vacated, 445 U.S. 939, 63 L.Ed.2d 773, 100 S.Ct.
hs 06 CAVERN Uae cece cd benteds.s dct,
Asiatic Petroleum Co. v. Commission of Internal Reve-
nue, T9F .2d 234 (2d Cir. 1935), certiorari denied, 296
U.S. 645, 80 L.Ed. 459, 56 S.Ct. 248 (1935), rehearing
denied, 296 U.S. 664, 80 L.Ed. 474, 56 S.Ct. 369 (1935)
Butler Brothers v. McColgan, 315 U.S. 501, 86 L.Ed.
991, 62 S.Ct. 701 (1942), affirming 17 Cal. 2d 664,
RE, RE SS a a Pa
Chicago Bridge & Iron v. Caterpillar Tractor Co., 84
Ill. 2d 102, 417 N.E. 2d 1343 ....................-.
Coca Cola Co. v. Department of Revenue, 271 Ore. 517,
EE OE oe ns enc vanidvasin sent.
Complete Auto Transit, Inc. v. Brady, 430 U.S. 274, 51
L.Ed. 2d 326, 97 S.Ct. 1076, rehearing denied, 430
UU Bohr cide coca. . Gees sacceddode
Container Corporation of America v. Franchise Taz
Board, 1/Civil 48990 (1981) ............ecseeeeeee
Edison California Stores, Inc. v. McColgan, 30 Cal. 2d
iy Se ae OO CRIED cc cpiitc ccccoscccvisesdveres
Ezxazon Corp. v. Wisconsin Department of Revenue, 447
U.S. 207, 65 L.Ed.2d 66, 100 S.Ct. 2109 (1980) ......
Hoeper v. Taz Commission of Wisconsin, 284 U.S. 206,
76 L.Ed. 248, 52 S.Ct. 120 (1931) ...............-.
17
13, 17
=
3
?
b
=
QO
ounty of Los Angeles, 441 U.S.
434, 60 L.Ed.2d 336, 99 S.Ct. 1813 (1979) ....... rae < 5 *
Mobil Oil Corp. v. Commission of Taxes, 445 U.S. 425,
63 L.Ed. 2d 510, 100 S.Ct. 1223 (1980) ............. 2, 13,
Montana Department of Revenue v. American Smelting
é Refining Co., 173 Mont. 316, 567 P.2d 901 (1977),
appeal dismissed, 434 U.S. 1042, 54 L.Ed.2d 793, 98
EE AG ey Ualbac sc ccoccnedeuanmenebuse 6,7
Moorman Manufacturing Co. v. Blair, 437 U.S. 267, 57
L.Ed.2d 197, 98 S.Ct. 2340 (1978) ..............2.- 17
National Carbide Corp. v. Commissioner, 336 U.S. 422,
93 L.Ed. 779, 69 S.Ct. 729 (1949) ...........ee eens 26
Northwestern States Portland Cement Co. v. Minne-
sota, 358 U.S. 450, 3 L.Ed.2d 421, 79 S.Ct. 357 (1959) 13
Railroad Taz Cases, 92 U.S. 575, 23 L.Ed. 663 (1875).. 17
Reeves, Inc. v. Stark, 447 U.S. 429, 65 L.Ed.2d 244, 100
EN Ds dba Ch didc¥:00c so décmeteseteecnes 13
U.S. Steel Corp. v. Multistate Tax Commission, 434
U.S. 452, 54 L.Ed.2d 682, 98 S.Ct. (1978) .......... 11,12
United States Constitution
Commerce Clause, Art. I, § 8, cl. 3 .............0005- 2,7
Fourteenth Amendment, §1 ...............0eeeeees 2, 25, 29
Statutes
Internal Revenue Code of 1939:
EE hu th cain c bac ctcoccccbvcbocedp ers eb 10
Internal Revenue Code of 1954 (26 U.S.C.)
CM UCR Ue cuipus es vsces duke des ben eeuewe 10
PAGE
Ge Bis wan Linus oys.¢ dn eu chbdbe nde « 22
Rein i de... i, che wh dbekacwaeas 23
UR Soe, an e's coc cde nvutebescevs 11
EG a DRPEUUS Cues 6c ccc cccdédedbecboses 11
28 U.S.C. :
EE 2
ER Sent Gla og bcceccecedsesescsune es 2
P. Law 86-272, Title I, § 101, Sept. 14, 1959, 73 Stat.
SE on on, occ cceusoctespecess 22
Illinois Income Tax Act (Ill. Rev. Stat., 1979, ch. 120,
par. 1-102 et seq.)
eR aE OM 6 sb ccedc cavadambeesiee 11
Ne SCRE. oc cc ccc ebebebeccueets 3
Se ee. coc codseneeed sau és 4
I EMER e cCEEEL «oo coccccgeccstectees 4
Other Authorities
ad Department Tax Reform Option Paper No.
SEL Ls Met ditb Pdaletiss 6000 ce cate sghaedae pa - -
Illinois Department of Revenue Proposed Regulations
(Illinois Register, Vol. 5, Issue 29, July 17, 1981):
oe ai ecessc cates vevbeveess 27
ES Pe Se re 16
Testimony of Paul W. Cook on behalf of the National
Association of Manufacturers before the House
Ways and Means Committee, on H.R. 5076 ........ 15
Testimony of Theodore W. DeLooze, Chief Tax Coun-
sel, Oregon Department of Revenue, before the
House Ways and Means Committee, on H.R. 5076.. 23
vii
Written statement of Joseph H. Guttentag, Dutch
Employers’ Federation, to the House Ways and
Means Committee, on H.R. 5076 .............2-55:
Statement of William O. Hetts, Partner, Deloitte, Has-
kins & Sells, before the House Ways and Means
nS ME ss, os be cdcbvebheseneces
Testimony of Donald C. Lubick, Assistant Secretary
of the Treasury for Tax Policy, before the House
Ways and Means Committee, on H.R. 5076 ........
Statement of John S. Nolan on behalf of the Confed-
eration of British Industry and the British National
Committee of the International Chamber of Com-
merce, before the House Ways and Means Commit-
EE es a, cin oaks Cas kbd bobeees
Testimony of Dr. Laurence N. Woodworth, Assistant
Secretary of the Treasury, on the Tax Treaties with
the United Kingdom, the Republic of Korea, and
the Republic of the Philippines, Hearings before the
Committee on Foreign Relations, U. 8S. Senate, 95th
Cong., Ist Sess. (1977), pp. 32-33 ................
Statement by Senator Ribicoff on worldwide combined
reporting, 115 Cong. Rec. 2597 .............00005:
Statement of Donald C. Lubick before the Senate
Finance Committee on 8-983 and S-1688 ..........
Revenue Act of 1934, Section 103 ...................
S. Rep. 558, 73rd Cong., 1939-1 (Part 2) C.B. 586, 610
Comments by Geoffrey Johnson Smith, Member of
Parliament; Peter Rees, Minister of State, Treas-
ury; and Michael Grylls, Member of Parliament;
Debates in the House of Commons, February 18,
1980, Hansard, Parliamentary Debates, p. 190 ....
D. Harnack and R. Hanson, The Continuing Contro-
versy Over Combination, 59 Taxes 531 (August
PLAC a data PO die de sc ccccdgcbécshepenneene 6
PAGE
19
19
19, 20,
22, 28
Supreme Court of the Gnited States
Ocroszr Tzam, 1981
CHICAGO BRIDGE & IRON COMPANY,
Appellant,
Vv.
CATERPILLAR TRACTOR CO., ILLINOIS
DEPARTMENT OF REVENUE, et al,
Appellees.
Appeal from the Supreme Court of Illinois
JURISDICTIONAL STATEMENT
OPINIONS BELOW
The order of the Circuit Court of Peoria County was en-
tered on February 9, 1979. The order is not reported, but
is printed in Appendix A. The opinion of the Illinois Ap-
pellate Court is reported in 77 Ill.App.3d 90, 395 N.E.2d
1167, and is printed in Appendix B; the opinion of the Illi-
nois Supreme Court is reported in 84 [1].2d 102, 417 N.E.2d
1343. It is printed in Appendix C.
JURISDICTIONAL GROUNDS
The opinion of the Illinois Supreme Court was filed on
February 20, 1981. A timely petition for rehearing was filed
by appellants and an order denying said petition was
entered on March 27, 1981. Said order is printed in Ap-
pendix D. The Notice of Appeal was filed on June 15, 1981.
The time for docketing this case was extended to August
24, 1981 by Justice Stevens on June 16, 1981. The juris-
diction of this Court is invoked under 28 U.S.C. § 1257(2)
and 28 U.S.C. § 2101(¢). Appellant squarely challenged the
constitutionality of the Illinois income tax, ar -onstrued to
require worldwide combined reporting, and the Illinois
Supreme Court squarely sustained its validity, as so con-
strued. Jurisdiction under 28 U.S.C. § 1257(2) is supported
by the recent decision in Japan Line, Ltd. v. County of Los
Angeles, 441 U.S. 434, 60 L.Ed.2d 336, 99 S.Ct. 1813 (1979),
as well as those in Mobil Oil Corp. v. Commissioner of
Tazes, 445 U.S. 425, 63 L.Ed.2d 510, 100 S.Ct. 1223 (1980),
and Exxon Corp. v. Wisconsin Department of Revenue, 447
U.S. 207, 65 L.Ed.2d 66, 100 S.Ct. 2109 (1980).
CONSTITUTIONAL PROVISIONS AND
STATUTE INVOLVED "
This case involves the constitutionality of the Lllinois
Income Tax Act under the Commerce Clause and the «due
process and equal protection provisions of the Fourteenth
Amendment to the United States Constitution. The appli-
cable Constitutional provisions are:
Congress shall have Power . .. To regulate Commerce
with foreign Nations, and among the several States, and
with the Indian Tribes. [Art. I, § 8, cl. 3]
. .. nor shall any State deprive any person of life,
liberty, or property, without due process of law; nor
deny to any person within its jurisdiction the equal
protection of the laws. [XIV Amend., § 1]
The Illinois Income Tax Act [Tll. Rev. Stat. 1979, ch. 120,
par. 1-101 et seq.] is printed in its entirety in Appendix E.
STATEMENT OF THE CASE
Caterpillar Tractor Co. and four of its subsidiaries (the
Caterpillar Companies) originally filed separate Illinois
corporate income tax returns for 1969 through 1974 inclu-
sive. Each corporation determined the amount of its income
subject to Illinois income tax by starting with its federal
taxable income, making adjustments thereto as required
by the Illinois Income Tax Act (the Act), and apportioning
its business income in accordance with the familiar three-
factor formula, based on property, payroll and sales, set
forth in section 304(a) of the Act. Thereafter, these corpo-
rations filed claims for refund with the Illinois Department
of Revenue (the Department), asserting that, in each case,
the amount of the corporation’s income subject to the
Illinois income tax should have been determined by com-
bined reporting.’
An administrative hearing was held on March 14 and 15,
1978, at which evidence was submitted and stipulations were
filed, including a supplemental stipulation filed August 3,
1978, in which the Department stated that its adminis-
trative practice requires use of combined reporting by
corporations conducting a unitary business. (Excerpts from
Record E-32, E-55, E-56.) In a Notice of Decision issued on
November 17, 1978, the Department agreed with the Cater-
pillar Companies that the operations of Caterpillar and all
of its domestic and foreign subsidiaries constituted a uni-
2 Under combined reporting, the business income attributable to
Illinois of a member of a related group of corporations meeting a
more-than-50% stock ownership test is determined by multiplying
the entire group’s business income by the average of the property,
payroll and sales factors. These factors are determined by dividing
the Illinois property, payroll and sales figures for each corporation
filing an Illinois income tax return by the total property, payroll
and sales figures of all members of the group. See, Illinois proposed
tions section 304-1(b) (2), Appendix G, pp. G-17-G-20.
4
tary business, and applied a combined three-factor formula
to the combined worldwide business income of the group.
(Excerpts from Record E-61, E-62.) However, the Depart-
ment denied certain deductions claimed by the Caterpillar
Companies and, on November 22, 1978, they sought admin-
istrative review in the Circuit Court of Peoria County.
(Excerpts from Record E-167.)
Appellant, Chicago Bridge & Iron Company (CBI),
timely filed Illinois income tax returns for the years 1969-
1973 using the separate, non-combined method of reporting
originally employed by the Caterpillar Companies. On June
21, 1976, the Department pursuant to section 904(c) of the
Act, issued to CBI a Notice of Deficiency asserting an
aggregate deficiency of $157,336.18 for the years 1969 and
1970, resulting from applying worldwide combined report-
ing to CBI and all of its subsidiaries. Pursuant to section
908(a) of the Act, on August 3, 1976, CBI protested the pro-
posed assessments. (Excerpts from Record E-200, E-201.)
No hearing has been held on such protest due to the pen-
dency of this case. Further, on May 8, 1980, the Department,
pursuant to section 904(c) of the Act, issued to CBI a Notice
of Deficiency asserting an aggregate deficiency of $837,527
for the years 1971-1973, resulting from applying worldwide
combined reporting to CBI and all of its subsidiaries. Pur-
suant to section 908(a) of the Act, CBI also protested these
proposed assessments. No hearing has been held on such
protest due to the pendency of this case.
Although the issue of the legality of worldwide combined
reporting had never been presented to, or decided by, an
Illinois court, the Caterpillar Companies and the Depart-
ment both favored such method of reporting. Therefore, in
the suit filed by the Caterpillar Companies in the Circuit
Court of Peoria County, the original parties acknowledged
combined reporting as a method which the Department
could require related corporations to employ. The com-
plaint merely raised questions as to how worldwide com-
bined income should properly be computed. Appellant stood
to be directly injured by the legal operation and effect of
a judgment determining the proper method of computing
worldwide combined income and implicitly upholding the
basic premise that worldwide combination is lawful. Ac-
cordingly, it sought leave to intervene as plaintiff oppos-
ing the lawfulness of combined reporting. The Circuit Court
granted leave both as of right and as a matter of judicial
discretion. Appellant’s status as party plaintiff was upheld
by the Appellate Court and by the Supreme Court.
The Circuit Court held that the Illinois Income Tax Act
requires worldwide combined reporting in the case of a
unitary business. In the Illinois Appellate Court, appellant
cited the then very recently decided case of Japan Line,
Ltd. v. County of Los Angeles, 441 U.S. 434, 60 L.Ed.2d
336, 99 S.Ct. 1813 (1979), holding that a fairly apportioned
tax imposed on instrumentalities of commerce domiciled
abroad violates the Commerce Clause. However, no refer-
ence was made to this issue in the Appellate Court’s opinion
upholding worldwide combined reporting. Appellant ap-
pealed to the Illinois Supreme Court, in which Commerce
Clause and Fourteenth Amendment arguments were ad-
vanced. The Court rejected both arguments, holding that
worldwide combined reporting violates neither the Com-
merce Clause nor the Fourteenth Amendment.
REASONS WHY QUESTIONS PRESENTED
ARE SUBSTANTIAL
The questions presented by this appeal are so substantial
as to require plenary consideration, with briefs on the
merits and oral argument, for their resolution. Appellant
is fully aware of the numerous decisions of this Court cited
in Exxon Corporation v. Wisconsin Department of Revenue,
447 U.S. 207, 65 L.Ed.2d 66, 100 S.Ct. 2109 (1980), to the
effect that:
... “the entire net income of a corporation, gener-
ated by interstate as well as intrastate activities, may
be fairly apportioned among the States for tax pur-
poses by formulas utilizing in-state aspects of interstate
affairs.” (447 U.S. at 219]
7 o .
“. .. Although separate geographical accounting may
be useful for internal auditing, for purposes of state
taxation it is not constitutionally required.”
[447 U.S. at 222-223]
The “linchpin of apportionability” for state income
taxation of an interstate enterprise is the “unitary
business principle.” ... If a company is a unitary
business, then a State may apply an apportionment
formula to the taxpayer’s total income in order to
obtain a “rough approximation” of the corporate in-
come that is “reasonably related to the activities con-
ducted within the taxing State.” [447 U.S. at 223]
However, this case presents no timeworn issue involving
the right of a state to tax a corporation upon a portion of
its total income derived from multistate or multinational
operations, determined by use of a formulary method of
apportionment. This case does not involve separate geo-
graphical or separate functional accounting.
This case presents to this Court, for the first time, two
vitally important issnes.* The first of these is whether a
3 Although combined reporting has been upheld in decisions in
California (e.g. Edison California Stores Inc. v. McColgan, 30 Cal.
2d 472, 183 P.2d 16 (1947)), Oregon (e.g. Coca Cola Co. v. Depart-
ment of Revenue, 271 Ore. 517, 533 P.2d 788 (1975), appeal dis-
missed, 434 U.S. 1042, 54 L.Ed.2d 793, 98 S.Ct. 884 (1978)) and
Montana (e.g. Montana Department of Revenue v. American Smelt-
7
state may constitutionally subject to tax a portion of the
income of a foreign corporation which is not doing busi-
ness in such State, if an entirely separate corporation which
is doing business in the State is related to such foreign
corporation and is engaged with it in conducting a “unitary
business.” Appellant submits that the imposition of a tax
on such foreign income, which is the inevitable result of
worldwide combined reporting, is precluded by the Com-
merce Clause of the United States Constitution.
The second, and equally vital issue, involves the basic
concept of combined reporting, interstate as well as world-
wide. Is it constitutional to measure the income of Corpora-
tion A which is subject to State income tax, by reference
to the income, property, payroll and sales of separate Cor-
porations B and C which are not subject to the tax? Ap-
ing & Refining Co., 173 Mont. 316, 567 P.2d 901 (1977) ), the consti-
tutional issues here presented do not appear to have been presented
to the state courts in those cases. They do not contain decisions on or
discussions of such issues, and neither Edison California Stores nor
Coca Cola was brought before this Court. American Smelting &
Refining Co. was dismissed for want of jurisdiction, 434 U.S. 1042
(1977). Another recent decision in this area of state taxation,
American Smelting & Refining Co. v. Idaho State Tax Commission,
99 Idaho 924, 592 P.2d 39 (1979), vacated, 445 U.S. 939, 63 L.Ed.2d
773, 100 S.Ct. 1333 (1980), did not present an issue concerning
combined reporting, but dealt with the classification of items
of income as business income subject to apportionment, rather
than as nonbusiness income subject to allocation. The California
Court of Appeal, in Container Corporation of America v. Franchise
Taz Board, 1/Civil 48990 (1981), recently held that worldwide
combined reporting is constitutional. Leave to appeal was denied by
the California Supreme Court. Although notice of appeal in that
case was filed on July 31, 1981, the time for docketing such appeal
in this Court does not expire until September 11, 1981, and the
appeal has not as yet been docketed to appellant’s knowledge. If an
appeal is docketed in such case, appellant urges this Court to hear
such appeal as well as the appeal in this case.
pellant believes that such measurement of the taxable
income of Corporation A is barred by the due process and
equal protection clauses of the Fourteenth Amendment.
This Court so held as to individuals in Hoeper v. Tax
Commission of Wisconsin, 284 U.S. 206, 76 L.Ed. 248, 52
S.Ct. 120 (1931); this case affords it a chance to apply
that holding to corporations.
L Combined Reporting Has Never Been
Presented to this Court
When a State seeks to impose an income tax on the
business income of a multistate or multinational corpora-
tion engaged in business in such State, two questions must
be answered in compliance with constitutional requirements.
It is first necessary to determine what is the amount of the
taxpayer-corporation’s business income, and, when that has
been determined, it is necessary to determine what portion
of the total business income is properly allocable to the
taxing jurisdiction.
Where a single corporation is involved, there is no ques-
tion as to the amount of its business income; all that is
required is to determine the proper method of allocating
such income among the various jurisdictions in which it
does business. The allocation historically used is commonly
referred to as separate accounting, under which the corpo-
ration’s business income is divided along geographical or
functional lines and the income attributable to a particular
jurisdiction is computed as though the business activities
conducted within the jurisdiction were its only business
However, if the business conducted by a single corporation
is a wnitary business, i.e., none of its income is derived
“from ‘unrelated business activity’ which constitutes a
‘discrete business enterprise’” [Exxon Corp., 447 U.S. at
224], separate accounting was early found to be inappro-
priate for determining what portion of the total business
income is allocable to a particular jurisdiction. In such
case, a tax imposed on “net income derived from business
done within this state,” determined by use of an apportion-
ment formula, was sustained by the California Supreme
Court in Butler Brothers v. McColgan, 17 Cal.2d 664, 111
P.2d 334 (1941), affirmed, 315 U.S. 501, 86 L.Ed. 991, 62 S.Ct.
94 (1942), the Court stating the governing principle as
follows:
. . . It is only if its business within this state is truly
separate and distinct from its business without this
state, so that the segregation of income may be made
clearly and accurately, that the separate accounting
method may properly be used. . . . If there is any evi-
dence to sustain a finding that the operations of ap-
pellant in California during the year 1935 contributed
to the net income derived from its entire operations in
the United States, then the entire business of appellant
is so clearly wnitary as to require a fair system of
apportionment by the formula method in order to
prevent overtaxation to the corporation or under-
taxation by the state. [17 Cal.2d at 667-668; emphasis
supplied]
This Court affirmed, holding that use of an apportionment
formula does not violate the Fourteenth Amendment where
a unitary business of a single corporate entity is involved.
[315 U.S. 501, 86 L.Ed. 991, 62 S.Ct. 701 (1942)] The Butler
Brothers holding has been frequently reaffirmed, most re-
cently in Exxon Corporation v. Wisconsin Department of
Revenue, 447 U.S. 207, 65 L.Ed.2d 66, 100 S.Ct. 2109 (1980),
and appellant readily acknowledges its correctness.
There is now no question but that formulary apportion-
ment is a constitutionally permissible method of allocating
a portion of a single corporation’s business income to a
taxing State.
10
However, where a taxpayer-corporation is a member of
a group of related corporations engaged in a business
involving intra-group transactions, the amount of the tax-
payer’s business income must be determined before any
attempt to allocate a portion thereof to the taxing State
can be made. Since transactions among members of the
group might otherwise be employed as devices to shift in-
come between members of the group, Internal Revenue
Code section 482 requires that the income of each member
of the group be determined as though it dealt only with
unrelated corporations, with necessary reallocations of in-
come and expense to accomplish this result. This method
of determining the amount of a corporation’s business in-
come is known as the arm’s-length method, and it is utilized
by most nations of the industrialized worid.* The constitu-
tionality of section 45 of the Internal Revenue Code of
1939 [the predecessor of section 482 of the 1954 Code] was
upheld in Asiatic Petrolewm Co. v. Commissioner of Inter-
nal Revenue, 79 F.2d 234 (2d Cir. 1935), certiorari denied,
296 U.S. 645, 80 L.Ed. 459, 56 S.Ct. 248 (1935), rehearing
denied, 296 U.S. 664, 80 L.Ed. 474, 56 S.Ct. 369 (1935),
and has not been questioned since.
A second method of determining the amount of business
income of a member of a group of related corporations
is combined reporting. Where the members of the group
are found to be conducting a unitary business, this method
assumes that the business income of each member of the
group constitutes a percentage of the combined business
income of the group as a whole. In allocating the combined
business income of the entire group to a jurisdiction in which
* Counsel for the Caterpillar Companies acknowledge that “the
accepted international apportionment method [is] the arm’s-length
Section 482 approach.” Don S. Harnack and Richard A. Hanson,
The Continuing Controversy Over Combination, 59 Taxes 531, 534
( August 1981).
ll
a particular taxpayer-corporation does business, the appor-
tionment formula used is that corporation’s instate appor-
tionment factors [property, payroll and sales, ete.) divided
by the entire group’s total factors, both instate and without
the state.®
This Court has never before been asked to resolve the
question of the constitutionality of combined reporting,
although it has recognized that there is a difference between
(i) requiring formulary apportionment of a single corpora-
tion’s unitary business income, and (ii) requiring combined
reporting of the income of multiple corporations.
U.S. Steel Corp. v. Multistate Tax Commission, 434 U.S.
452, 54 L.Ed.2d 682, 98 S.Ct. 799 (1978), did not involve
the constitutionality of combined reporting. The attack in
the U.S. Steel case was not on combined reporting, but on
the Multistate Tax Commission’s authority to conduct multi-
state audits using such method. This Court rejected piain-
tiffs’ position, because it found that “Since appellants do
not contest the right of each State to adopt these procedures
if it conducted the audits separately, they cannot be heard
to complain that a threat to federal supremacy arises from
the Commission’s adoption of the unitary-business standard
in accord with the wishes of the member States.” [434 U.S.
at 474)
5 Unlike the making of a consolidated return under the Internal
Revenue Code, which is an election available to members of an
affiliated group of corporations meeting an 80% stock ownership
test [Internal Revenue Code sections 1501, 1504], combined report-
ing is mandatory with respect to members of a related group of
corporations meeting a more-than-50% stock ownership test. See,
Illinois proposed Regulations sections 300-2(c), 304-1(b) (2), Ap-
pendix G, pp. G-4-G-9, G-17-G-20. Illinois does not allow the filing
of consolidated returns. [Ill. Rev. Stat., ch. 120, § 2-203]. A foreign
corporation may not be included in an affiliated group for purposes
of filing a consolidated return for federal income tax purposes.
[Internal Revenue Code, section 1504]
12
This Court carefully drew a distinction between formu-
lary apportionment and combined reporting. It noted that
the former has been upheld by its own decisions, whereas
combined reporting rests entirely on a decision of the
California Supreme Court which was not there challenged:
The “unitary business” technique involves calculat-
ing a corporate taxpayer’s net income on the basis of
all phases of the operation of a single enterprise (¢.g.,
production of components, assembly, packing, distribu-
tion, sales), even if located outside the jurisdiction.
The portion of that income attributable activities
within the taxing State is then determined by means
of an apportionment formula. See, e.g., Underwood
Typewriter Co. v. Chamberlain, 254 Us. 113 (1920).
Nena of income” involves applying the unitary
business concept to separately incorporated entities
engaged in a single enterprise. See Ediscn California
Stores, Inc. v. McColgan, 30 Cal.2d 472, 183 P.2d 16
(1947) [434 U.S. at 473, n. 25]
+ . *
Individual States are free to employ the unitary-
business standard. Underwood Typewriter Co. v. Cham-
berlain, supra; accord, Bass, Ratcliff € Gretton, Ltd.
v. State Taz Comm’n., 266 U.S. 271 (1924). Nor do
appellants claim that individual States could not em-
ploy the combination method of determining taxpayer
income. Cf. Edison California Siores, supra. (434 U.S.
at 474, n. 26]
It is precisely the asserted power of the State of Illinois
to require combined reporting that appellant does challenge
in this appeal.
IX Worldwide Combined Reporting Creates a Substantial
Risk of International Multipie Taxation, Thereby
Violating the Gommerce Clause
In holding that worldwide combined reporting does not
offend the Commerce Clause, the Illinois Supreme Court
placed reliance upon the perceived fact that the three-
13
factor apportionment formula applied to worldwide com-
bined income may be said to be fair. In seeking to distin-
guish this Court’s decision in Japan Line, Ltd. v. County
of Los Angeles, 441 U.S. 434, 60 L.Ed.2d 336, 99 S.Ct. 1813
(1979) the Illinois Court stated:
... The purpose of the apportionment formula is to
confine the taxation of business income to that portion
which is attributable to activities in Illinois. This ap-
peal does not involve the multiple taxation of items or
instrumentalities of foreign commerce nor does unitary
reporting affect federal authority in governing foreign
commerce. The concern here is only with the taxation
of business income fairly attributable to activities
within the taxing state. [84 I1].2d at 123]
In support of this statement the Court cited Mobi! Oil Corp.
v. Commissioner of Taxes, 445 U.S. 425, 63 L.Ed.2d 510,
100 S.Ct. 1223 (1980); Complete Auto Transit, Inc. v.
Brady, 430 U.S. 274, 51 L.Ed.2d 326, 97 S.Ct. 1076 (1977) ;
and Northwestern States Portland Cement Co. v. Minne-
sota, 358 U.S. 450, 3 L.Ed.2d 421, 79 S.Ct. 357 (1959). How-
ever, each of these cases involved solely interstate rather
than foreign commerce, whereas Japan Line and the instant
case present situations where a substantial risk of inter-
national multiple taxation is present. As this Court noted
in Mobil, supra, “Japan Line . . . focused on problems of
duplicative taxation at the international level, while ap-
pellant here has confined its argument to the wholly differ-
ent sphere of multiple taxation among our States.” [445
U.S. at 448)
As this Court reiterated in Reeves, Inc. v. Stark, 447 U.S.
429, 65 L.Ed.2d 244, 100 S.Ct. 2271 (1980); “. . . Commerce
Clause scrutiny may well be more rigorous when a restraint
on foreign commerce is alleged.” [447 U.S. at 438, n. 9]
Indeed, in Japan Line, this Court recognized that, if purely
interstate commerce were involved, “Complete Auto would
apply and be satisfied, and our Commerce Clause inquiry
14
would be at an end.” [441 U.S. at 445] However, where
foreign commerce is involved, two additional consicera-
tions come into play:
. .. The first is the enhanced risk of double taxation.
It is a commonplace of constitutional jurisprudence
that multiple taxation may well be offensive to the Com-
merce Clause. .. . In order to prevent multiple taxation
of interstate commerce, this Court has required ‘hat
taxes be apportioned among taxing jurisdictions, so
that no instrumentality of commerce is subjected to
more than one tax on its full value. The corollary of
the apportionment principle, of course, is that no jur-
isdiction may tax the instrumentality in full... .
Yet neither this Court nor this Nation can ensure full
apportionment when one of the taxing entities is a
foreign sovereign. If an instrumentality of commerce
is domiciled abroad, the country of domicile may have
the right, consistently with the custom of nations, to
impose a tax on its full value. If a State should seek
to tax the same instrumentality on an apportioned
basis, multiple taxation inevitably results. Hence,
whereas the fact of apportionment in interstate com-
merce means that “multiple burdens logically cannot
occur,” Washington Revenue Dept., 435 U.S. at 746-
747, the same conclusion, as to foreign commerce, logi-
cally cannot be drawn. Due to the absence of an
authoritative tribunal capable of ensuring that the ag-
gregation of taxes is computed on no more than one
full value, a state tax, even though “fairly apportioned”
to reflect an instrumentality’s presence within the state,
may subject foreign commerce “ ‘to the risk of a double
tax burden to which [domestic] commerce is not ex-
posed, and which the commerce clause forbids.’” Evco
v. Jones, 409 U.S., at 94 quoting J. D. Adams Mfg. Co.,
304 U.S. at 311. [441 U.S. at 446-448]
Thus, the “fairness” of an apportionment formula is ir-
relevant when foreign commerce is involved.
Worldwide combined reporting inevitably causes double
taxation resulting solely from apportionment. Treasury De-
partment Tax Reform Option Paper No. VIII, dealing with
15
interpational taxation, discussed a proposal to require
States to use arm’s-length reporting rather than worldwide
combined reporting. The Treasury set forth the following
reasons, among others, for and against this proposal:
Pro—
The arm’s-length standard, upon which corporations
apply to inter-firm transactions those prices which
would have been used by an independent buyer and
seller, has become the international method of allo-
eating income between countries. When one country or
the states within that country apply an unconventional
rule, international double taxation of income results.
As state income tax rates have increased, this double
taxation has become more onerous.
Con—
State tax administrators believe that the unitary
method yields higher state tax revenues (this ad-
vantage being the other side of the double taxation
coin), and as a result vigorously oppose Federal restric-
tions on their practices. [Emphasis supplied]
The Treasury recommended that “The States should be
prohibited from applying the unitary apportionment rule to
tax foreign income of foreign corporations.” The relevant
text of Tax Reform Option Paper No. VIII is printed at
Appendix F.*
That apportionment of the worldwide combined income
of a group of corporations, some of which are foreign cor-
porations, inevitably results in international double taxa-
* See, also, testimony of Dr. Laurence N. Woodworth, Assistant
Secretary of the Treasury, on the Tax Treaties with the United
Kingdom, the Republic of Korea, and the Republie of the Philip-
pines, Hearings before the Committee on Foreign Relations, U.S.
Senate, 95th Cong., Ist Sess. (1977), pp. 32-33. The testimony of
Paul W. Cook on behalf of the National Association of Manufac-
turers before the House Ways and Means Committee, March 31,
1980, on H.R. 5076, contains a graphic example of egregious double
taxation.
16
tion may be readily demonstrated. Assume that Illinois
subsidiary S and foreign parent, P, are precisely equal
in the dollar value of their property, payroll and sales, and
that they conduct a “unitary business,” but that all trans-
actions between the two are conducted on an arm’s-length
basis so that reallocation of their incomes is not called
for. P earns $200,000 and pays tax thereon in the foreign
country of its commercial doricile. S has no net income,
but merely breaks even. S pays no U.S. income tax. How-
ever, if combined reporting is employed, the combined
worldwide income of the group is $200,000, and S, the
Illinois taxpayer, is subject to Illinois income tax on
$200,000 multiplied by the apportionment factor which, in
this case, is 50%." S pays Illinois income tax on $100,000.
One-half of P’s income has been subjected to double taxa-
tion, although not one dollar of such income may ever be
transferred to the United States or become subject to U.S.
income tax. Such double taxation is inherent in combined
reporting, which creates not merely a substantial risk, but
a virtual certainty, of international double taxation.
It is, of course, also true that worldwide combination
may result in a State income tax advantage for some cor-
porations. If, in the above example, S earned $200,000, but
P merely broke even, use of combined worldwide reporting
would result in apportioning $100,000 of S’s income out of
Illinois. Worldwide combined reporting results in double
taxation of the incume of foreign corporations whenever
such corporations are more profitable than domestic cor-
porations. When the foreign operations of a group are less
successful than its domestic operations, then worldwide
combined reporting reduces the State income tax of the
domestic members of the group. This explains the Cater-
7 See, Section 304-1(b)(2) of proposed regulations published by
the Illinois Department of Revenue in Volume 5, Issue 29 of the
Illinois Register on July 17, 1981. These proposed regulations are
printed at Appendix G. See pp. G-17-G-20.
17
pillar Companies’ claims for refund of Illinois income tax,
and their enthusiastic support for worldwide combined
reporting. However, the fact that worldwide combined re-
porting may result in unjustifiable undertazation in some
instances cannot justify unconstitutional overtazxation in
others. This is not a case where two wrongs make a right.
As was true in Japan Line, it could be argued that any
multiple taxation which results from worldwide combined
reporting is attributable, not to the State imposing such
system, but to the country of domicile of a foreign corpo-
ration which fails to adopt it. However, this Court there
held that while such argument “may have force in the
interstate commerce context,” “this Court is powerless to
correct malapportionment of taxes imposed from abroad
in foreign commerce.” [441 U.S. at 454] In Mobil Oil Corp.
v. Commissioner of Taxes, 445 U.S. 425, 63 L.Ed.2d 510,
100 S.Ct. 1223 (1980), it was recognized that “Taxation
by apportionment and taxation by allocation to a single
situs are theoretically incommensurate, and if the latter
method is constitutionally preferred, a tax based on the
former cannot be sustained.” (445 U.S. at 444-445] Where
foreign governments are concerned, taxation by allocation
to the situs of commercial domicile is the rule and this
preference cannot be affected by this Court. Accordingly,
taxation by apportionment of worldwide combined income
cannot be sustained.*
* In passing, it should be noted that, while Japan Line involved
a property tax, rather than an income tax, its principles are fully
applicable to the latter, as is evident from the fact that, in Japan
Line, this Court began its discussion with Complete Auto Transit,
supra, a case involving a franchise tax on gross receipts, and by the
manner in which it treated and distinguished Moorman Manufactur-
ing Co. v. Bair, 437 U.S. 267, 57 L.Ed.2d 197, 98 S.Ct. 2340 (1978),
a corporate income tax case relied upon by the State taxing author-
ities. Indeed, the “unitary” concept was first developed in property
tax cases. [State Railroad Tax Cases, 92 U.S. 575, 23 L.Ed. 663
(1875) ; Adams Express Co. v. Ohio State Auditor, 165 U.S. 194, 41
L.Ed. 683, 17 S. Ct. 305 (1896) }
18
III. Combined Reporting Prevents the Federal Government
From ‘‘Speaking With One Voice When Regulating
Commercial Relations with Foreign Governments,’’ and
Creates a Risk of Retaliation by Foreign Governments,
Thereby Violating the Commerce Clause
The [Illinois Supreme Court, in seeking to distinguis.
Japan Line, stated “. . . nor does unitary reporting affect
federal authority in governing foreign commerce.” In truth,
however, it frustrates the achievement of federal uniform-
ity in precisely the ways which this Court there noted:
. .. If the State imposes an apportioned tax, interna-
tional disputes over reconciling apportionment formu-
lae may arise. If a novel state tax creates an asymmetry
in the international tax structure, foreign nations dis-
advantaged by the levy may retaliate against American-
owned instrumentalities present in their jurisdictions.
(441 U.S. at 450]
As long ago as February 4, 1969, Senator Ribicoff made
the following points concerning worldwide combined re-
porting :
A major objection to the unitary concept is that the
California practice requires the inclusion in unappor-
tioned tax base of “foreign source income” which is
earned in countries outside of the United States and
which is not even included in the measure of the Fed-
eral income tax imposed by the United States, For
example, under the California practice, a Connecticut
corporation—with an affiliate in California and other
affiliates in such countries as Holland, France, Japan,
and so forth—is required to include in the measure of
the California tax the income of the foreign affiliates as
well as the income of the California affiliate and the
Connecticut affiliate. Besides being highly inequitable,
this practice conflicts directly with the international
taw policies of the Federal Government and, if per-
mitted to continue, can result in a situation in which
various States of the United States are formulating
their own international tax policies without taking into
19
account the international trade policies of the Federal
Government. [115 Cong. Rec. 2597]
Donald C. Lubick, Assistant Secretary of the Treasury
for Tax Policy, testifying in support of H.R. 5076 before
the House Ways and Means Committee on March 31, 1980,
criticized worldwide combined reporting in the following
terms:
The practice has created, and continues to create, an
irritant in the international relations of the United
States. A number of foreign governments have com-
plained, both officially and informally, that the unitary
system differs from the arm’s-length method used by
the Federal Government and generally accepted in
international practice. [Emphasis supplied]
See, also, Mr. Lubick’s statement before the Senate Finance
Committee on S. 983 and S. 1688, June 24, 1980.
William O. Hetts, a tax partner in the international ac-
counting firm of Deloitte Haskins & Sells, with over 300
offices in 66 countries, has stated that “the unitary method,
when applied to multinational entities, disrupts efforts to
achieve harmony and uniformity in the taxation of com-
merce between the countries of the world and invites re-
taliation by foreign countries in which subsidiaries of U.S.
companies operate.” [Statement before House Ways and
Means Committee, March 31, 1980, on H.R. 5076] Mr. Hetts’
statement is printed in Appendix H.
John 8S. Nolan, speaking on behalf of the Confederation
of British Industry on H.R. 5076, noted:
The Council of the OECD [Organization for Eco-
nomic Cooperation and Development] in July, 1979,
adopted a recommendation for uniform, worldwide use
by countries of the separate accounting, arm’s-length
principle, rather than any formula apportionment
method. This was based on a 100-page report setting
out a number of methods of establishing “accept-
able price levels” for determining intercompany arm’s-
length prices, in which it is clear that the United
States Treasury Regulations under § 482 were given
close attention. The OECD action reflects the consensus
of the Governments who are members of the OECD,
including the United States, that separate accounting
employing arm’s-length standards is the only appro-
priate system for taxation of international transactions.
[Appendix I-40]
Mr. Nolan’s full statement is printed in Appendix I.
Indeed, so strongly do our trading partners feel on this
subject that all nine members of the European Common
Market joined in a demarche to the State Department
“reciting the litany of problems with worldwide combined
reporting, including compliance costs, inequities, double
taxation, inconsistency with internationally accepted rules
and incompatibility with principles adopted by the OECD.”
[Written statement of Joseph H. Guttentag to the House
Ways and Means Committee, March 31, 1980, on H.R. 5076,
on behalf of the Dutch Employers’ Federation. }
A recently adopted tax treaty between the United States
and the United Kingdom would have barred State use of
combined reporting, but in the final draft of the treaty,
this provision was dropped.’ In the debate in the House
of Commons as to whether the revised treaty should be
adopted, on February 18, 1980, a Member of Parliament,
Mr. Geoffrey Johnson Smith, referred to the combined
method as “international robbery,” and Mr. Peter Rees
{the Minister of State, Treasury] replied that “strong
feelings ... are certainly present on the Government side.”
However, another Member, Mr. Michael Grylls, took hope
from this Court:
One cheerful factor is the comment of the United
States Supreme Court that counters the arguments of
® Although the provision was approved by a vote of 49-32 in the
Senate, there were insufficient votes to obtain the necessary 34 in
favor of the treaty with this provision included.
21
those who stress the delicacy of matters related to
state rights. The Supreme Court said:
“The United States must speak with one voice
regarding such international activities.”
It is not right for individual states to speak with dif-
ferent voices on matters of international business.
{Hansard, Parliamentary Debates, p. 190]
Worldwide combined reporting is contrary to interna-
tionally accepted methods of taxation, is strenuously op-
posed by foreign nations, and is contrary to Federal
policy."” In holding that a State statute is void because it
conflicts with Federal policy, this Court has not required an
express Congressional prohibition. Specifically, in the area
of State taxation, this Court held in Japan Line:
... it long has been “accepted constitutional doctrine
that the commerce clause, without the aid of Congres-
sional legislation . . . affords some protection from
state legislation inimical to the national commerce, and
that in such cases, where Congress has not acted, this
Court, and not the state legislature, is under the com-
merce clause the final arbiter of the competing demands
of state and national interests.” Southern Pacific Co.
v. Arizona ex rel. Sullivan, 325 U.S. 761, 769 (1945).
Accord, Hughes v. Oklahoma, ante, at 326, and n. 2;
Boston Stock Exchange v. State Tax Comm’n., 429 U.S.
318, 328 (1977). [441 U.S. at 454-455]
Worldwide combined reporting “discourages foreign in-
vestment in the United States and, thus hurts U.S. employ-
ment, the balance of payments and the extent of competi-
10 Even counsel for the Caterpillar Companies concede that “for-
eign corporations and their governments view combined reporting
as a violation of the normal international procedures for appor-
tioning income.” They conclude that “Absent a U.S. Supreme Court
determination that worldwide combination is unconstitutional,
relief for the foreign corporations appears to depend on congres-
sional action.” Don S. Harnack and Richard A. Hanson, The Con-
tinuing Controversy Over Combination, 59 Taxes 531, 534 (Au-
gust 1981). Appellant urges such determination by this Court.
tion in the U.S. industries.” {Tax Reform Option Paper
No. VIII] When worldwide combination results in taxation
of the income of a foreign corporation related to a U.S.
corporation doing business in a State in which the foreign
corporation does no business, and with which it has no con-
nection, it violates the policy concepts embodied in such
diverse pieces of legislation as Public Law 86-272 [15
U.8S.C.A. § 381], which imposes limits on the taxation of
interstate income of a corporation when that corporation
has only minimal contacts with the taxing State, and In-
ternal Revenue Code section 882(b), expressing the general
rule that only the income of a foreign corporation from
sources within the United States is taxed.
Worldwide combined reporting is also contrary to the
policy of the United States, as expressed in numerous
treaties, both Tax Treaties and Treaties of Friendship and
Commerce, all of which have recognized that the arm’s-
length standard is to be the basis of taxation of inter-
national business. See the in-depth discussion of these
treaties by Mr. Nolan in Appendix I, pp. I-31-I-37.
To see that the risks of international retaliatory taxation
are acute, if worldwide combined reporting is not struck
down, it is necessary only to look to our own Internal Rev-
enue Code. Section 891 of that Code provides that whenever
the President finds that U.S. citizens or corporations are
subjected to discriminatory or extraterritorial taxation by
a foreign country, citizens or corporations of that country
are, pursuant to his proclamation, to be subjected to U.S.
taxes at double the rate ordinarily applicable. This provi-
sion was first enacted in 1934, as section 103 of the Revenue
Act of 1934. The House version applied only where foreign
taxes were discriminatory, but the Senate extended the
provision to extraterritorial taxes with the comment:
In the first place, the section is made to apply if the
foreign country levies extraterritorial taxes, as well
as discriminatory taxes. Thus, a tax on income not
properly within the jurisdiction of the foreign country
imposing such tax will come within this classification.
[S.Rep. 558, 73rd Cong., 1939-1 (Part 2) C.B. 586, 610]
See, also, Internal Revenue Code, section 896. If worldwide
combined reporting is viewed as “international robbery,”
is it unlikely that a statute comparable to section 891 will
be adopted abroad to the detriment of all U.S. businesses?
In Japan Line, this Court noted that the tax there held
invalid “creates an asymmetry in international . . . taxation
operating to Japan’s disadvantage.” This, it found, created
an acute risk of retaliation which would be felt by the
Nation as a whole. Further, it noted that, if other States
were to impose a similar tax, varying degrees of multiple
taxation would be imposed, depending on the taxing juris-
diction involved. It concluded:
... This result, obviously, would make “speaking with
one voice” impossible. California, by its unilateral act,
cannot be permitted to place these impediments before
this Nation’s conduct of its foreign relations and its
foreign trade. [441 U.S. at 453]
Worldwide combined reporting creates an asymmetry in
international income taxation, which operates to the dis-
advantage of our international trading partners. The risk of
retaliatory action is acute. And, since combined reporting
exists in varying forms in only a relatively few States,"'
11 Theodore W. DeLooze, Chief Tax Counsel, Oregon Department
of Revenue and a spokesman for combined reporting, testified
before the House Ways and Means Committee, March 31, 1980, on
H.R. 5076, that “there are probably five or six or seven” States
which use the concept. (Official Transcript, p. 53) The Caterpillar
Companies asserted in the Illinois Supreme Court that ten States
employ it.
24
and is likely to be inconsistently applied in those States
which adopt it, varying degrees of multiple taxation are
imposed, depending on the taxing jurisdiction involved.
Worldwide combined reporting makes “speaking with one
voice” impossible. No State (in this case Illinois) can be
permitted to place these impediments on the Nation’s for-
eign relations and foreign trade.
The Illinois Supreme Court failed to acknowledge the
landmark case of Hoeper v. Tax Commission of Wisconsin,
284 U.S. 206, 76 L.Ed. 248, 52 S.Ct. 120 (1931), and there-
fore erroneously held that due process is not violated by
combined reporting, placing reliance on the perceived
“reasonableness” of the apportionment formula used in
conjunction with combination. Appellant acknowledges that
Butler Brothers v. McColgan, 315 U.S. 501, 86 L.Ed. 991,
62 S.Ct. 701 (1942), and Exxon Corp. v. Wisconsin Depart-
ment of Revenue, 447 U.S. 207, 65 L.Ed.2d 66, 100 S.Ct. 2109
(1980), as well as numerous other decisions, have estab-
lished that due process does not compel use of separate
geographical or functional accounting as opposed to for-
mulary apportionment, so long as the formula is reason-
able and the requirement of nexus is also met. Appellant
also agrees that due process is not contravened merely be-
cause a taxpayer’s income from international activities may
be subjected to a fairly apportioned tax, as held in Mobil
Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 63 L.Ed.
2d 510, 100 S.Ct. 1223 (1980).
However, that an apportionment formula meets the re-
quirements of due process in apportioning the income of a
single taxpayer is irrelevant to the question whether com-
25
bining the incomes of separate taxpayers meets the re-
quirements of the Fourteenth Amendment. Hoeper, supra,
holds tha: such combination is unconstitutional.
In that case, this Court was called upon to determine the
validity of a State income tax law which imposed combined
reporting on members of a family. The statute required that
the incomes of the wife and children under 18 years of age
be combined with that of the husband, and that a tax be
levied against the husband based on such combined income.
It further provided that, if separate returns were filed, the
tax should be computed on the “combined average taxable
income” and should be paid by the husband and the wife
“in the proportion that the average income of each bears
to the combined average income.” This statute bore an
uncanny resemblance to the concept of combined reporting
as applied to corporations.
This Court noted that, at common law, the wife’s prop-
erty is the property of her husband, and said that, if this
were her status, “the statutory attribution of her income
to her husband for income tax would, no doubt, be justi-
fiable.” [284 U.S. at 214] However, since, under applicable
law, the wife’s income was her separate property, “the
question presented is whether the state has power by an
income-tax law to measure his tax, not by his own income
but, in part, by that of another.” The Court answered that
question as follows:
. . . To the problems thus stated, what was said in
Knowlton v. Moore, 178 U.S. 41, 77, is apposite:
“It may be doubted by some, aside from express
constitutional restrictions, whether the taxation by
Congress of the property of one person, accompanied
with an arbitrary provision the’ the rate of tax shall
be fixed with reference to the su» of the property of
another, thus bringing about the profound inequality
which we have noticed, would not transcend the limita-
tions arising from those fundamental conceptions of
free government which underlie all constitutional sys-
tems.”
We have no doubt that, because of the fundamental
conceptions which underlie our system, any attempt by
a state to measure the tax on one person’s property
or income by reference to the property or income of
another is contrary to due process of law as guaranteed
by the Fourteenth Amendment. That which is not in
fact the taxpayer’s income cannot be made such by
calling it income. Compare, Nicols v. Coolidge, 274 U.S.
531, 540. [284 U.S. at 215)
In Hoeper, it was argued that the statute was necessary
to prevent fraud and evasions of the tax by married persons.
The Court gave this argument short shrift:
“That is to say, ‘A’ may be required to submit to an
enactment forbidden by the Constitution if this seems
necessary in order to enable the State readily to collect
lawful charges against ‘B’. Rights guaranteed by the
federal Constitution are not to be so lightly treated;
they are superior to this supposed necessity. The State
is forbidden to deny due process of law or the equal
protection of the laws for any purpose whatsoever.”
The claimed necessity cannot justify the otherwise
unconstitutional exaction. [284 U.S. at 217]
This Court long ago held that subsidiaries must be
treated as separate taxpayers from their parent corpora-
tions, saying, “Complete ownership of the corporation, ancl
the control primarily dependent upon such ownership—the
important ingredients of the Southern Pacific case—are no
longer of significance in determining [federal income] tax-
ability.” [National Carbide Corp. v. Commissioner, 336 U.S.
422, 429, 93 L.Ed. 779, 69 S.Ct. 729 (1949)] The Court
specifically held that, to the extent the “testimony shows the
integration of the corporate system and its direction by
27
Airco, it is, as we have indicated, immaterial.” [336 U.S. at
433-434, n. 13] It is precisely such testimony which would
show the operation of a “unitary business,” yet the opera-
tion of such a business does not make the income of the
subsidiary that of the parent. Combined reporting, on the
other hand, goes even further; it makes the income of the
parent the income of the subsidiary, if it is the subsidiary
which is subject to tax in the State employing such method.
If foreign parent P and Illinois subsidiary S are of equal
size, but P earns $200,000 and S earns nothing, as discussed
above, combined reporting requires that $100,000 of the
combined income be treated as that of S and sibjected to
tax in Illinois. If S’s competitor, X, is precisely the same ©
size as S, but also earns nothing, X pays no tax. S is severely
disadvantaged in its competition with X, and, being a sub-
sidiary, has no means to compel P to remit to it any portion
of P’s profits with which to pay its tax. A clearer case in
which neither due process nor equal protection of the laws
has been afforded S it would be hard to find.
Other examples abound. Under the proposed [Illinois
Regulations Section 300-2(c) (2), combined reporting can be
required in any case of more than 50% common ownership.
{Appendix G-6] Many foreign countries require that local
citizens or the foreign government itself be permitted to
own a significant percentage of a local subsidiary of a U.S.
parent. Appellant’s Saudi subsidiary is 25% locally owned;
its Indonesian subsidiary is 50% locally owned. Suppose
‘at parent P, located in Illinois, owns 50.1% of the stock
of subsidiary S, located in a foreign country, and the gov-
ernment of that country owns 49.9% of S. P is nine times
as large as S in property, payroll and sales, but, separately
stated, each earns $1,000,000 on an arm’s-length basis. Under
combined reporting 90% of the combined income of the two
corporations ($1,800,000) is apportioned to P and sub-
jected to tax in Illinois, even though P has no equity what-
ever in $499,000 of S’s earnings. Even if P repatriates by
means of dividend the full $501,000 of S’s earnings to which
it is entitled, the Illinois income tax is imposed on $299,000
of S’s income which has a permanent foreign situs and to
which P has no claim of right. Not only is this imper-
missible double taxation of S’s foreign income as previously
discussed, but it renders P non-competitive with corpo-
rations based abroad or in other States, the incomes of
which are not subject to combined reporting and which pay
no tax on the income of a subsidiary until such time as
some or all of such income is received by the parent.
It is the assumption upon which the concept of combined
reporting and three-factor apportionment is premised that
an equal amount of property, payroll and sales will produce
an equal amount of income. Thus, if three related corpora-
tions are precisely the same size, their combined business
income will be apportioned 4% to each of the three. [See
proposed Illinois Regulations Section 304-1(b)(2). Appen-
dix G, pp. G-17-G-20] How ver, it has been noted that, in
1979, the average per hour wages for a worker in the United
States were $9.09, and that such wages in other countries
varied from $8.17 in France through $5.58 in Japan, $5.46
in the United Kingdom, $1.80 in Brazil to $0.65 in Indonesia.
Appendix I, p. 1-49. It is obvious that there is no necessary
correlation between productivity and payroll where different
countries are involved. Indeed, productivity may well be
higher in countries with lower wage rates than in the United
States. Even within the United States, variances in union-
ization, the cost of living, and other factors occasion sub-
stantial differences in wage rates, yet combined reporting
assumes that a smaller payroll means a smaller proportion-
ate share of the combined income.
U.S. laws require the expenditure of large sums for pol-
lution control equipment. Such expenditures do not enhance
29
profitability, but under combine! reporting, profits of for-
eign affiliates will be tilted toward the State where a U.S.
corporation is situated because of that State’s greater
proportion of a combined property factor. Similarly, if a
corporation such as appellant is engaged in heavy manu-
facturing in the U.S., and has subsidiaries engaged in a
contracting business abroad, the heavily capital intensive
nature of its manufacturing business will cause a substan-
tial portion of its subsidiaries’ contracting profits to be ap-
portioned to the State where the manufacturing is conducted.
Even a combined sales factor often results in significant
distortions of income. Both political and commercial risk
factors vary tremendously from location to location as a
multistate-multinational group of corporations does busi-
ness around the globe. Where risks are greater, business
will not be transacted unless the gross profit margin is
sufficiently large to justify the assumption of those risks.
Can anyone doubt that no U.S. corporation would conduct
business in Iran at this time unless it believed that a dollar
of sales there would produce a substantially higher profit
than a dollar of sales in Illinois? But a combined sales
factor disregards this fact.
While this Court has refused to impose strict constitu-
tional restraints under the Due Process Clause on a State’s
selection of a particular formula for apportioning the in-
come of a single corporation to such State [Moorman
Manufacturing Co. v. Bair, 437 U.S. 267, 57 L.Ed.2d 197,
98 S.Ct. 2340 (1978)], to require combination of the in-
comes of entirely separate corporations, related by little
more than 50% common ownership, incorporated under
entirely dissimilar local laws, doing business many thou-
sands of miles and many cultures apart, goes far beyond
the application of an apportionment formula. Such com-
bination of incomes cannot withstand scrutiny under the
Fourteenth Amendment.
30
CONCLUSION
For the foregoing reasons, it is earnestly requested that
probable jurisdiction be noted.
Respectfully submitted,
Wituam P. Sutter
One First National Plaza
Chicago, Illinois 60603
(312) 558-6616
Attorney for Appellant
Of Counsel:
Ricnarp Bromiey
One First National Plaza
Chicago, Illinois 60603
(312) 558-6614
xIpuddty
Office- Supreme Court, US.
FILED
Ty. 49 AUG 24 1981
ALEXAND:# L. STEVAS,
CLERK
IN TBE
Supreme Court of the United States
Octoser Term, 1981
CHICAGO BRIDGE & IRON COMPANY,
Appellant,
v.
CATERPILLAR TRACTOR CO., ILLINOIS
DEPARTMENT OF REVENUE, et al.
Appellees.
Appeal from the Supreme Court of Illinois
APPELLANT’S APPENDIX
Wis P. Sutrer
One First National Plaza
Chicago, Illinois 60603
(312) 558-6616
Attorney for Appellant
Of Counsel:
Ricnarp BroMLey
One First National Plaza
Chicago, Illinois 60603
(312) 558-6614
i]
TABLE OF CONTENTS
Appendix A—Order of the Circuit Court
Appendix B—Opinion of the Illinois Appellate Court
Appendix C—Opinion of the Illinois Supreme Court
Appendix D—Denial of Rehearing by Illinois Supreme
Court
Appendix E—lIllinois Income Tax Act
Appendix F—Tax Reform Option Paper No. VIII
Appendix G—Proposed Illinois Income Tax Regula-
tions
Appendix H—Statement of William O. Hetts, Partner,
Deloitte Haskins & Sells, before the
House Ways and Means Committee on
H. R. 5076
Appendix I—Statement of John S. Nolan on behalf of
the Confederation of British Industry
and the British National Committee of
the International Chamber of Com-
merce, before the House Ways and
Means Committee on H. R. 5076
APPENDIX A
A-1
IN THE CIRCUIT COURT OF
THE TENTH JUDICIAL CIRCUIT OF ILLINOIS
PEORIA COUNTY
CASE NO. 78L 7815
CATERPILLAR TRACTOR CO., et al.
Plaintiff
vs.
ILLINOIS DEPARTMENT OF REVENUE AND
DANIEL J. LENCKOS, Director
Defendant
ORDER
THIS CAUSE COMING ON TO BE HEARD this 9th
day of February, 1979 and the Court BEING FULLY AD-
VISED IN THE PREMISES:
IT IS HEREBY ORDERED AS FOLLOWS:
(1) The Petitioners, Coca-Cola et al., are entitled to inter-
vene both as a matter of right and by discretion of this
Court. Intervention is granted only as to the issue of law:
whether the unitary apportionment method must be applied
under the Illinois Income Tax Act to achieve fair represen-
tation of a taxapayer’s business actively in Lllinois. The
Petitioners are not entitled to intervene as to any factual
issue and no determination is made herein as to whether the
intervenors are unitary business operations.
(2) The Unitary Apportionment Method must be applied
by the Illinois Department of Revenue in order to fairly rep-
resent the Plaintiffs’ business activities in Illinois during
the taxable years 1970-1974.
A-2
(3) The Unitary Apportionment Method must be applied
by the Illinois Department of Revenue in order to fairly
represent the Plaintiffs’ business activity in Illinois during
the taxable year 1969, providing however, that is shall be
applied only in determining the Department’s right to offset
to Plaintiffs’ Claim for Refund of overpayment. The use of
the Unitary Apportionment Method is not authorized as a
basis for determining a deficiency with respect to the tax-
able year 1969.
(4) Allegedly fictitious income, including deemed divi-
dend income, subpart F income and foreign income taxes
paid by C. T. Co. and its domestic subsidiaries which were
credited for federal tax purposes are deductible in comput-
ing income subject to apportionment.
(5) Foreign taxes paid by foreign subsidiaries included
in the Unitary group are deductible in computing unitary
worldwide group income under the Illinois Income Tax Act.
Stephen J. Covey
Judge of the Tenth Judicial Circuit
APPENDIX B
B-1
STATE OF ILLINOIS
APPELLATE COURT THIRD DISTRICT
OTTAWA
At a term of the Appellate Court, begun and held at
Ottawa, on the Ist Day of January in the year of our Lord
one thousand nine hundred and seventy-nine, within and for
_ the Third District of Illinois:
Present—
HONORABLE ALLAN L. STOUDER,
Presiding Justice x
HONORABLE JAY J. ALLOY, Justice
HONORABLE RICHARD STENGEL, Justice x
HONORABLE TOBIAS BARRY, Justice
HONORABLE ALBERT SCOTT, Justice x
JOSEPH FENNESSEY, Clerk
BE IT REMEMBERED, that afterwards on October 10,
1979 the Opinion of the Court was filed in the Clerk’s Office
of said Court, in the words and figures following, viz:
B-2
Case No. 79-104
IN THE
APPELLATE COURT OF ILLINOIS
Tuirp District
A.D. 1979
————EEESEoEoEaEaEaaooooeEEeEEeeeeee___=QSQSSQQQSQOESOOEOQOOSOOOONQqEanaanE=—SS—XKXvwmN=
CATERPILLAR TRACTOR CO., .
CATERPILLAR AMERICAS CO.,
CATERPILLAR CREDIT CORP.,
CATERPILLAR FINANCE CORP.,
AND CATERPILLAR
MACHINERY CORP.,
Plaintiff-Appellees,
Cross-Appellants,
vs. On appeal from the
Cireuit Court of the
DANIEL J. LENCKOS, as Acting Tenth Judicial
Director of the ILLINOIS a —
DEPARTMENT OF REVENUE, - —”’
and Honorable
ILLINOIS DEPARTMENT OF Stephen J. Covey,
REVENUE, Presiding Judge.
Defendants-A ppellants,
Cross-Appellees,
COCA-COLA COMPANY, et al.,
Intervening Plaintiff s-
Appellants,
MULTISTATE TAX COMMISSION,
Amicus Curiae. 7
B-3
Mr. PRESIDING JUSTICE STOUDER delivered the
opinion of the court:
There is no dispute as to the facts pertinent to the issues
presented on this appeal. Caterpillar Tractor Co. is a
California corporation with its principal headquarters at
100 N.E. Adams Street, Peoria, Illinois. Caterpillar Trac-
tor Co. is the parent corporation of a number of sub-
sidiaries in the United States and foreign countries. Certain
of these subsidiaries are also subject to Illinois income tax
and their cases were joined with hat of Caterpillar Trac-
tor Co. before the Illinois Department of Revenue, (here-
inafter referred to as the Department), before the court
below and in this appeal. Joined were, Caterpillar Ameri-
cas Co. (“Americas”), Caterpillar Credit Corp. (“Credit”),
Caterpillar Finance Corp. (“Finance”) and Caterpillar
Machinery Corp. (“Machinery”). Coca-Cola and fifteen
other companies were permitted to intervene by the trial
court. On appeal we permitted the Multistate Tax Com-
mission to file an amicus curiae brief.
Caterpillar Tractor Co. and its subsidiaries together con-
stitute the largest manufacturer of earthmoving, construc-
tion and materials handlirs equipment in the world. Each
of the companies carries out one or more production,
marketing, and service functions as part of an integrated
enterprise. For example, Caterpillar Tractor Co. produces,
sells and services virtually every item in the Caterpillar
line of products. Americas, Caterpillar Overseas, S.A.,
and Caterpillar Far East, Ltd., are marketing companies
which engage in sales and service functions in specific
geographic areas. Caterpillar Tractor Co., Ltd., Cater-
B-4
pillar Belgium, Caterpillar of Canada, Caterpillar of
Australia and other subsidiaries manufacture and sell com-
ponents of, or complete machines in, the Caterpillar prod-
uct line. Other companies such as Caterpillar Overseas
_ Credit Corporation, S.A., Caterpillar of Delaware, and
Credit provide financing and other services to other Cater-
pillar companies and to independent Caterpillar dealers
which market Caterpillar products in their particular area.
Many of the Caterpillar machines are manufactured by
more than one of the Caterpillar companies. Each type of
machine, wherever manufactured, is identical to other
machines manufactured at other plants throughout the
world. Worldwide product uniformity permits maximum
product and part intercharuc and allows any particular
company to manufacture noi on, .ts own product but also
components to be used in the manufacture of products by
other Caterpillar companies. Consequently, there is a high
degree of intercompany sales of parts and components.
Product uniformity also allows for substantial uniformity
of advertising, warranties, employee training and other
aspects of the business carried on by each company.
Worldwide product uniformity is maintained by having
the responsibility for design control, product specifications
and quality assigned to a central design group located at
Caterpillar Tractor Co.’s general office in Peoria. In order
to further promote uniformity of products and to maximize
the efficient operation of all of the companies, Caterpillar
Tractor Co. exercises centralized direction over its sub-
sidiaries, including a direction and control over manu-
facturing standards, budgets, accounting, compensation
leveis and benefits, insurance, labor contracts, and research
and development. As a result of the nature and operations
of Caterpillar Tractor Co. and its subsidiaries, their opera-
B-5
tions are integrated with, dependent upon, and contribute
to the overall success of the business activities of the group
carried on throughout the world.
Caterpillar Tractor Co. and each of the subsidiaries
subject to tax in Illinois, hereinafter referred to jointly as
the plaintiffs, initially filed Illinois income tax returns for
each of the years 1969 through 1974 on a separate basis
utilizing the statutory apportionment formula. In these
separate returns each company, where appropriate, sub-
tracted from its federal taxable income deemed dividends
includible in federal taxable income under Section 78 of the
Internal Revenue Code (hereinafter referred to as “deemed
dividend income”) and Subpart F income and deducted
their own foreign income taxes paid or accrued which each
company had credited for federal income tax purposes.
The Department audited the plaintiffs’ returns for each
of the years 1969 through 1974 and denied the subtractions
for the deemed dividend income and Subpart F income and
foreign income taxes, proposing additional assessments of
tax as a result of these adjustments. The plaintiffs paid
said assessments, but on February 21, 1974, they each filed
refund claims for the years 1969, 1970 and 1971, (excepting
Finance which filed a claim for 1971 only) requesting the
refund of the amount of the assessments paid plus addi-
tional amounts resulting from the further subtraction of
foreign dividends, interest and royalties to the extent in-
cluded in base income on a non-unitary basis.
With one exception, the claims for refund relating to the
taxable year 1969 were not timely filed since the three year
period prescribed by the statute of limitations had expired.
On May 18, 1973, Caterpillar Tractor Co. paid additional
income tax and interest for the 1969 taxable year totaling
$175,965.37. Therefore, the period of limitations had not
B-6
expired as to this sum of $175,965.37. Six months later, on
August 21, 1974, these claims were deemed denied, and sub-
sequently protests to this deemed denial of their claims
were filed in which hearings were requested.
On October 15, 1974, timely supplemental claims for re-
fund of overpayments for 1970 and 1971 were filed asserting
the applicability of the unitary apportionment method.
Protests to the denial of these claims were filed on May 19,
1975.
On May 7, 1976, each of the taxpayers filed timely supple-
mental claims for refund of overpayment for the years 1972
through 1974. Claims also asserted the applicability of the
unitary apportionment method.
Thereafter, as a result of audit examinations, 30 day
letters were issued by the Department to the taxpayers for
the years 1969 through 1974. The taxpayers responded with
timely statements of objections, and notices of a deficiency
were issued by the Department on March 8, 1978, for the
tax years 1969 through 1974. Timely protests were filed on
March 10, 1978, and on March 14 and 15, 1978, an adminis-
trative hearing was held before the Illinois Department of
Revenue.
The Department issued a notice of decision which held,
in relevant part, that the operations of Caterpillar Tractor
Co. and its domestic and foreign subsidiaries constituted a
unitary business during the period August 1, 1969 to De-
cember 31, 1969, and for each of the calendar years 1970 to
1974. The Department agreed with the plaintiffs that a fair
apportionment of the income of Caterpillar Tractor Co.
and its subsidiaries to Illinois could only be achieved
through application of the unitary method of apportionment.
Consequently, the Department found that the plaintiffs
should be allowed, as they had requested, to use the unitary
B-7
method of apportionment in determining their income tax
liability in each of the years 1970 through 1974.
In addition to the Department’s ultimate findings regard-
ing the existence of a unitary business and the applicability
of the unitary method of apportionment for the year 1970
through 1974, the Department made certain subsidiary
findings regarding the method of computing the plantiffs’
Tllinois income tax liability on the unitary method of appor-
tionment. Finally, the Department determined that the
plaintiffs were also required to use the unitary method of
apportionment in 1969 even though such use had not been
requested by the plaintiffs.
Administrative review of this determination was sought,
and on February 9, 1979, the lower court issued an order
approving the plaintiffs’ use of the unitary method of
apportionment for 1970 through 1974. The court also ap-
proved the plaintiffs’ method of computing liability under
the unitary method, i.e., deducting allegedly fictitious in-
come, including deemed dividend income, Subpart F income
and foreign income taxes paid by the Caterpillar Tractor
Co. and its domestic subsidiaries as well as Jeducting for-
eign taxes of foreign subsidiaries includible in the unitary
group. However, the court decided that the unitary method
was applicable in determining offsets to the plaintiffs’
claimed overpayment of Illinois tax for the 1969 period.
In addition, it was determined that sixteen corporations
were entitled to intervene concerning the issues of whether
the unitary apportionment method must be applied under
the Illinois Income Tax Act, but intervention was not
allowed as to any factual question, no determination having
been made as to whether the intervenors are unitary busi-
ness operations.
B-8
Initially, this court must address an issue raised by the
Department concerning the propriety of the decision of
the circuit court to permit the intervention of the sixteen
corporations. Although the right to seek review of an ad-
ministrative determination is limited to parties of record
in the proceeding before the administrative agency whose
rights, privileges or duties are affected by the decision
(Lake County Contractors Association v. Pollution Control
Board (1973), 54 Ill. 2d 16, 294 N.E.2d 259; Allender v.
City of Chicago Zoning Board of Appeals (1978), 63 Ill.
App. 3d 204, 381 N.E.2d 4), intervention may be granted
at the administrative review level to entities which do not
meet those requirements, as long as the requirements of
the intervention statute are satisfied. (Will County Board
of Review v. Property Tax Appeal Board of the Department
of Revenue (1971), 48 Ill. 2d 513, 272 N.E.2d 32). Further-
more, once intervention is allowed, the intervening party
may institute an appeal from an adverse determination.
(See Exchange National Bank of Chicago v. City of Chi-
cago (1963), 28 Ill. 2d 341, 192 N.E.2d 343).
Pursuant to the provisions of the Illinois Statute allow-
ing for interventions in a circuit court, the circuit court in
the case at bar, in addition to permitting intervention as
a matter of discretion, found that the sixteen corporations
had a right to intervene. However, if permissive interven-
tion was appropriately permitted, it becomes unnecessary
to determine whether the petition should have been granted
as of right. (See L.S. Heath d Sons, Inc. v. Marathon Oil
Company (1977), 56 Ill. App. 3d 440, 371 N.E.2d 1139).
In the discretion of the circuit court, a person may be
permitted to intervene if a timely application is made and
the applicant’s claim or defense has a question of law or
fact in common with the main action. (Ill. Rev. Stat. 1977,
ch. 110, par. 26.1(2)(b)). While it is unnecessary for a
B-9
person seeking to intervene to demonstrate a direct inter-
est in the suit (Mensik v. Smith (1960), 18 Ill. 2d 572, 166
N.E.2d 265), the application must exhibit a specific enforce-
able or recognizable right greater than the interest of the
general public in the subject matter of the suit (Cooper
v. Hinrichs (1957), 10 Ill. 2d 269, 140 N.E.2d 293).
Of course, when a determination of an issue lies within
the sound discretion of the trial court, in this case inter-
vention, the trial court’s determination will not be reversed
absent a clear showing of an abuse of discretion. (United
Steel Workers of American, Local 5292 v. Bailey (1975),
29 Ill. App. 3d 392, 329 N.E.2d 867). The petitioners in the
case at bar, should the judiciary approve the use of the
unitary method of apportionment of income, would be
prejudiced in their own disputes with the Department. Not
only is it important to allow a person to protect an interest
which may be jeopardized by pending litigation to which
that person is not a party, but it is desirable for reasons
of judicial efficiency to avoid relitigating in another suit
an issue which is already being litigated, (Bredberg v.
City of Wheaton (1962), 24 Ill. 2d 612, 182 N.E.2d 742).
Certainly the question of whether the unitary method of
apportionment is available under the [Illinois Income Tax
Act, the intervenors claiming it is not, is a question of
law in common with a question of law in the main action.
Therefore, intervention was properly allowed.
It is the Department’s contention, on the other hand,
that the intervenors are seeking a declaratory judgment in
a tax matter, which, according to the Department, is im-
permissible. We recognize the principles employed by the
Department. Specifically, a declaratory judgment will gen-
erally not be awarded in a tax case unless injunctive relief
would have been merited. (People ex rel Hamer v. Jones
(1968), 39 Ill. 2d 360, 235 N.E.2d 589). Injunctive relief
B-10
may be used to prevent a tax being levied on property
which is not subject to the tax, but it will not be employed
to halt the collection of revenue, even for irregularities in
the collection, because to so allow may well cause the
government to cease operating entirely. (The Chicago,
Burlington & Quincy R.R. Co. v. Frary (1859), 22 Ill. 34).
Regardless of the subject matter of the case, injunctive
relief will not be granted unless there is no adequate rem-
edy at law, which generally means that all possible admin-
istrative remedies must be exhausted. (Illinois Bell Tele-
phone Co. v. Allphin (1975), 60 Ill. 2d 350, 326 N.E.2d 737).
It is the Department’s complaint that the intervenors ought
to be required to proceed with their individual cases
through administrative proceedings or to use some other
acceptable method to avoid that consequence, such as péy-
ing the taxes under protest and thereafter seeking judicial
review. (See, Chicago ¢ Midland Ry. Co. v. Department of
Revenue (1976), 63 Ill. 2d 474, 349 N.E.2d 22).
While recognizing these principles, we cannot agree with
the recommendation of the Department to reverse the cir-
cuit court’s determination on the issue of intervention based
on these authorities. Having already determined that inter-
vention is appropriate in this factual situation, we must
point out that seeking intervention in an existing suit is
quite different from initiating a suit to avoid an adminis-
trative determination in a particular case. Where interven-
tion is allowed, the rights of the intervenors are generally
not determined directly. However, those rights may be
indirectly determined, and usually are because to seek
intervention requires that a specific interest in the subject
matter of the suit be demonstrated. And so, in this case
the courts are not directly declaring the rights of the
sixteen intervenors in their disputes with the Department
nor are the results of those disputes being determined in
advance. Instead, the intervenors have merely been given
B-11
an opportunity to present their points of view in a case
which, when determined, will likely affect the outcome of
those tax disputes. No declaratory judgment is sought here.
Since the circuit court’s ruling on intervention was cor-
rect, we must consider the issue raised by the intervenors,
whether or not the use of the unitary method of determining
income is authorized or permitted by the Illinois Income
Tax Act (Til. Rev. Stat. 1977, ch. 120, par. 1-101, et seq.).
The Illinois Income Tax Act statutes in controversy were
based on the Uniform Division of Income for Tax Purposes
Act (UDITPA). During the years in question UDITPA
was a part of the Illinois Income Tax Act (Multistate Tax
Compact. Ill. Laws 1967 Sess., at 661.) Before proceeding,
however, the unitary method of apportionment must be
described.
The formula adopted by the State of Illinois to determine
the income of a corporation attributable to activities within
the State involves a two-step process. Non-business income,
once determined, is allocated based on specified rules. The
portion of the business income allocable to Illinois is deter-
mined by means of an apportionment formula which applies
an apportionment factor, the average of the percentages of
the total property, the total payroll and the total sales
attributable to activity in Illinois, to the corporation’s busi-
ness income to determine that portion of the business in-
come properly apportioned to Illinois. Obviously, the cor-
poration’s total taxable income in [Illinois is its business
income apportionable to Illinois plus the non-business in-
come allocable to Illinois.
An extension of this approach, the unitary method, can
be applied where a unitary business is conducted by a
number of corporations. The application of the unitary
method is intended to solve the problem of accurately
identifying the portion of the business income of each
B-12
member of the unitary business which is attributable to
a given state. First, the income of each group member is
computed, with non-business income being identified and
allocated separately as appropriate. Having arrived at the
actual business income generated by the group, each mem-
ber’s individual apportionment factor is calculated by
determining the ratio of the individual corporation’s Illinois
property, payroll and sales to the combined property, pay-
roll and sales of the group, respectively, and then finding
the average of the three elements. The resultant apportion-
ment factor of the individual corporation is applied to the
total group business income to determine the business in-
come of the individual corporate taxpayer attributable to
Illinois. Again, taxable income is the sum of non-business
income allocated to Illinois and the business income of the
group member attributable to Illinois.
Several other states that have adopted UDITPA have
held that it authorizes the unitary method of apportionment
in determining what taxes a corporation owes that state.
These states have relied principally on Edison California
Stores, Inc. v. McColgan (1947), Cal.2d , 183 P.2d
16, in which the California Supreme Court held that the
California tax statute allowed unitary apportionment. One
section of the California act provided that if the entire
business of the corporation was not done within the state,
the tax should be measured by that portion thereof derived
from business within the state, determined by a method of
allocation based upon sales, purchases, expenses of manu-
facture, payroll, value and situs of tangible property or any
of them or of other factors, or by such other method of
allocation as may be fairly calculated to assign to the state
the portion of net income reasonably attributable to busi-
ness done within the state. Another section provided that
net income be computed in accordance with the regular ac-
B-13
counting method of the taxpayer, but if that method does
not clearly reflect income, the computation must be made in
accordance with a method designated by the commissioner
which clearly does reflect the income. And another section
allowed for consolidated returns.
The Califonria court held that under the statute unitary
apportionment was valid, adding that the power to apply
the unitary method was not dependent on the power to
require consolidated returns. Instead the power flowed from
the authorized method of ascertaining the income attri-
butable to a taxpayer’s activities within the state. This
holding is buttressed by cases in other states which have
upheld the unitary apportionment method without the need
for consolidated returns. (See Montana Department of
Revenue v. American Smelting and Refining Co. (Mont.
1977), 567 P.2d 901, Coca-Cola Co. v. Department of
Revenue (1975), 271 Or. 517, 533 P.2d 788)
The utilization of the unitary method does not ignore the
corporate structure. Each individual corporation is taxed
separately. The unitary method is only a device to ascertain
the income attributable to the Illinois business activity of
the taxpaying corporation. As a result, the express ban
of consolidated returns in the reporting of income for IIli-
nois income tax purposes (Ill. Rev. Stat. 1977, ch. 120, par.
2-203(d)(2)(E)) is irrelevant to a determination of whether
the unitary method of apportionment is to be used in
Illinois.
The major advantage of the unitary method is that, with
regard to the taxation of a parent company and its various
subsidiaries, there is no elevation of form over substance.
Without the unitary method were would be a different tax
application for an integrated business which is run as a
number of separate corporations rather than a single
B-14
multistate corporation. (See Coca-Cola Co. v. Department
of Revenue (Or. 1975), 533 P.2d 788). Since the whole
point of the income tax act is to ascertain that portion
of the business which is done within the state, there is no
reason to find different results based simply on the formal
structure of the business.
As mentioned earlier, the great majority of cases in other
jurisdictions have interpreted UDITPA as authorizing the
unitary method of apportionment. We agree with this
interpretation and hold that on the basis of the Multistate
Tax Compact being in effect at that time, the Department
of Revenue was correct in applying the unitary method of
apportionment. We stress that because we hold this way,
we do not reach the issue of whether or not articles 2 and
3 of the Illinois Income Tax Act authorize a unitary method
of apportionment.
Finally, the court is asked to consider a number of issues
in which the contestants are only the plaintiffs and the
Department. The first of these issues is how, or whether,
the unitary apportionment method is to be applied to the
fiscal year 1969 (August 1969 to December 31, 1969). The
circuit court determined that the unitary apportionment
method was applicable to 1969 but the Department could
not utilize it in recomputing the plaintiffs’ returns so as
to declare a deficiency even though it could be used by the
Department to offset the plaintiffs’ claims for refund. The
fact around which the circuit court’s determination centers
is that a statute of limitations prohibited the Department
from assessing additional income taxes for 1969 later than
October 15, 1973.
Without question, the trial court’s ruling is proper. Never-
theless, both parties attack it. The Department wants this
court to approve its declarations of deficiencies based on
B-15
the application of the unitary apportionment method to the
entire taxable year of 1969, while the plaintiffs would like
this court to declare that the unitary apportionment method
is not even available to determine an offset against the
' @laim for refund.
A notice of deficiency, to be effective, must not be issued
later than three years after the date the return was filed,
and unless such notice is timely given, a deficiency cannot
be assessed or collected. (Ill. Rev. Stat. 1977, ch. 120, par.
9-905(a)). If, however, the taxpayer fails to report a change
or correction, which change or correction is treated as if it
were a deficiency for federal income tax purposes, a notice
of deficiency may be issued at any time. (Ill. Rev. Stat.
1977, ch. 120, par. 9-905(d)). A fair reading of this ex-
ception to the statute of limitation would require that the
deficiency declared by the Department be based on the
federal change. The unitary method of apportionment is in
no way related to the federal changes involved in this case.
Therefore, the Department cannot utilize the unitary
method of apportionment as a basis for declaring a de-
ficiency as to plaintiffs’ 1969 income taxes.
This was the interpretation the Department initially ap-
plied, basing their proposed additional tax liabilities for
plaintiffs’ fiscal year 1969 on the federal changes alone
and utilizing the method of apportionment originally em-
ployed by the taxpayers in their returns, on their refund
claim and in the Department’s prior audit. Subsequently,
however, the hearing officer abandoned this approach and
decided that the deficiency, as well as the overpayment, be
‘computed by using the unitary method. Since the findings
of the Department are prima facie correct (III. Rev. Stat.
1977, ch. 120, par. 9-904(a)) and since the findings may be
prima facie evidence of the correctness of the amount of
B-16
tax due even against a claim of the Department (Austin
Liquor Mart, Inc. v. Department of Revenue (1972), 51
Tl. 2d 1, 280 N.E.2d 437 (dissent) ), the plaintiffs argue that
the hearing officer should not have abandoned a presump-
tively correct method of apportionment.
This argument of the plaintiffs need not now be con-
sidered since it has already been explained that the applica-
tion of the unitary apportionment method to the fiscal year
of 1969 to determine a deficiency was incorrect. On the
other hand, a refund is not authorized unless there is, in
fact, an overpayment. Even though the statute of limita-
tions bars the assessment and collection of additional taxes,
payments already receive may be retained to the extent
those funds do not exceed the amount which might have
properly been assessed and demanded. (See, Lewis v.
Reynolds (1931), 284 U.S. 281, 52 S.Ct. 145, 76 L.Ed. 293).
As a result, the unitary method of apportionment must be
applied to taxable year 1969 in order to determine to what
extent overpayments were made, thereby computing the
amount refundable to the plaintiffs.
Simply stated, the remaining issue is whether the plain-
tiffs should be allowed to claim certain deductions for pur-
poses of determining a refund for fiscal year 1969 as well
as in conjunction with the application of the unitary method
of apportionment in the subsequent years. In its determina-
tion, the circuit court would allow the deduction of certain
fictitious income in computing the income subject to ap-
portionment, including deemed dividend income, Subpart
F income and foreign taxes paid by the Caterpillar Tractor
Company, its domestic subsidiaries and its foreign sub-
sidiaries. To make this determination, we believe, was
beyond the province of the circuit court.
B-17
For the years in question, none of these deductions have
been authorized by the legislature. Instead, the Illinois In-
come Tax Act has relied, for its definition of taxable income,
on that taxable income properly reportable for federal in-
, come tax purposes (Ill. Rev. Stat. 1969, 1971, 1973, ch. 120,
par. 2-203(d)(1)). Only subsequently has the Illinois Gen-
eral Assembly created a deduction for one of these items,
foreign taxes. (Ill. Rev. Stat. 1975, ch. 120, par. 2-203(b)
(2)(F), amended by P.A. 79-1022, effective October 1, 1975).
Since such a statutory amendment creates a presumption
that it was intended to change the former law (Chicago &
Illinois Midland Ry. Co. v. Department of Revenue (1976),
63 Ill. 2d 474, 349 N.E.2d 22), it becomes clear that the
former law did not provide for such a deduction, even
impliedly.
These deductions now claimed by the plaintiffs arise from
their need to add hypothetical income to their federal in-
come tax return by reason of certain elections allowed to be
made by a taxpayer under the Internal Revenue Code of
1954. To compensate, the taxpayer is allowed a correspond-
ing credit to offset the additional income for federal income
tax purposes. For example, deemed dividend income occurs
if a domestic corporation is deemed to have paid a portion
of the foreign taxes paid by the subsidiary. The deemed
taxes may be claimed as a foreign tax credit only if an off-
setting amount is treated as dividend income received by
the domestic corporation. (26 U.S.C. sections 78 & 902).
The election concerning foreign taxes is even more clear-
cut. Foreign taxes paid by a domestic corporation may be
deducted by the taxpayer (26 U.S.C. section 164(a)(3)) or
credited against the tax due to the federal government (26
U.S.C. sections 78 & 901-908).
B-18
In making these elections, the taxpayer has, presumably,
lessened its federal income tax liability. Now, the plain-
tiffs in this case also want to reduce their Illinois income tax
liability by reversing the effect of their elections. This is
authorized, according to the plaintiffs, because the “prop-
erly reportable” language of the Illinois Income Tax Act is
not equivalent to “properly reported”. Therefore, the plain-
tiffs argue, this fictitious income need not be included for
Illinois income tax purposes because its exclusion from re-
ported income for federal income tax purposes would also
have been proper.
Having made their elections, the sematic distinction is no
longer available. The Illinois statute clearly expresses a
legislative intent that taxable income for Illinois income
tax purposes is that taxable income arrived at for federal
income tax purposes as long as the method employed to
compute taxable income for federal tax purposes was proper
under the Internal Revenue Code. Federal net income is
certainly a reasonable starting point for determining corpo-
rate net income for Illinois income tax. (Warren Realty Co.
v. Department of Revenue (1978), 62 Tll. App. 3d 450, 379
N.E.2d 100). As a result of their own elections, the plaintiffs
have not deducted the amount of foreign taxes from and
have added certain hypothetical income to their gross in-
come, and for federal income tax purposes, they are bound
by those elections. Nothing in our existing Illinois law can
be found to relieve the plaintiffs of the consequences of their
choices for Illinois income tax purposes. (See, Albany Inter-
aational Corp. v. Halperin (Me., 1978), 388 A. 2d 902). The
granting of such a deduction is a privilege created as a
matter of legislative grace, and no one is entitled to a deduc-
tion not clearly allowed by statute, the burden being on the
taxpayer to demonstrate entitlement to the claimed deduc-
tion. (Bodine Electric Co. v. Allphin (1979), 70 Til. App. 3d
B-19
844, 389 N.E.2d 168). A deduction being a matter of legisla-
tive grace, a court has no authority to create such a deduc-
tion as the circuit court herein allowed. This action of the
circuit court must be deversed.
Accordingly, the judgment of the circuit court ul Peoria
County is affirmed in part and reversed in part, and the
cause is remanded for a redetermination of the plaintiffs’
refund for fiscal year 1969 and the plaintiffs’ taxes for tax-
able years 1970 to 1974, not inconsistent with this opinion.
Affirmed in part, reversed in part and remanded.
STENGEL and SCOTT, JJ., concur.
APPENDIX C
C-1
ILLINOIS SUPREME COURT
Docket Nos. 52818, 52828, 52903 cons.—Agenda 43—
May 1980.
CATERPILLAR TRACTOR CO. et al., Appellants and
Cross-Appellees, v. DANIEL J. LENCKOS, Director
of Revenue, e¢ al., Appellants and Cross-Appellees.
MR. JUSTICE WARD delivered the opinion of the
court:
The plaintiffs, Caterpillar Tractor Company and four
of its corporate subsidiaries, filed separate Dlinois corpo-
rate income tax returns for 1969 through 1974 inclusive.
Each corporation, whose business income is generated
through multistate and multinational business operations,
in preparing its return applied the apportionment formula
set out in section 304(a) of the [Illinois Income Tax Act
(Ill. Rev. Stat. 1969, ch. 120, par. 3—304(a)) for the use
of corporations deriving business income from transactions
in Dllinois and in one or more other States. A purpose of
the apportionment formula is to confine taxation to the
portion of corporate income attributable to business opera-
tions within [linois.
Under section 304(a), the Director of Revenue (Direc-
tor) applies a three-factor (sales, payroll and property)
apportionment formula which separately compares the
total value of a corporation’s in-State and out-of-State
sales, payroll, and property, both tangible and intangible,
with the total value of the corporation’s in-State sales,
payroll, and property alone. To illustrate: if the total multi-
state sales of a corporation are $10 million and its total
Illinois sales are $1 million, the Illinois sales would repre-
sent one-tenth of the total multistate sales of the corpo-
ration, giving a sales factor of 10%. Once the percentage
of the other factors, payroll and property, is calculated,
C-2
the three factors are averaged. This average is then multi-
plied by the total amount of business income generated
by the corporation’s in-State and out-of-State operations.
If, for example, the sales, payroll and property multistate
factors of the corporation are each 10% and its combined
business income is $20 million, the amount of business in-
come attributable to Illinois is $2 million.
This method of apportionment was applied by each of
the plaintiff corporations in order to determine the portion
of income upon which Illinois could properly impose its
corporate income tax. (Ill. Rev. Stat. 1969, ch. 120, par.
2—201(b)(2).) The Illinois tax paid by the five corpora-
tions for the six years in question totaled $37,238,681.60.
The separate returns filed by each of the plaintiffs showed
deductions claimed for taxes paid to foreign governments
in other countries which had been credited for Federal
income tax purposes. The plaintiffs also deducted certain
dividend income includable in Federal taxable income (26
U.S.C. sec. 78 (1976)) as well as income obtained under
subpart F of the Internal Revenue Code. 26 U.S.C. secs.
951 through 964 (1976).
Between February of 1974 and Mey of 1976, each of the
plaintiffs filed separate claims with the Director for re-
funds covering 1969 through 1974. They claimed that for
the period of 1970-74, by using separate apportionment
they misapplied the apportionment formula of section
304(a) and, instead, should have applied the unitary method
of apportionment when calculating the percentage of each
plaintiff’s business income attributable to operations within
Illinois. Because of this misapplication, or failure to apply
the unitary method, the plaintiffs claimed that each of them
paid a greater tax than it was liable for under the Illinois
Income Tax Act.
>
C-3
The unitary apportionment methvud or as it is described
in the case of a group of commonly owned and controlled
corporations, the combined reporting method of reporting
the income of the plaintiffs from what are literally world-
wide sources, should have been applied, the plaintiffs said,
since they qualified as a unitary business group. A unitary
business operation is one in which there is a high degree
of interrelationship and interdependence between, typically,
one corporation, which generally is a parent corporation,
and its corporate subsidiaries or otherwise associated cor-
porations, which group is usually engaged in multistate,
and in some cases in international, business operations.
Because of this integrated relationship, which is reflected
in all phases of the business operations, it is extremely
difficult, for purposes of taxation, to determine accurately,
the measure of taxable income generated within a State
by an individual corporation of the unitary group which
is conducting business in the State. Typically, tae corpo-
ration’s transactions and the income derived from them
actually represent the business efforts of the individual
corporation, plus efforts of other and possibly all mem-
bers of the unitary business operation. As a result, the
claimed income of each member of the group standing
alone does not, in a real sense, reflect the conducting of
a unitary business operation because the income is not
attributable solely to the effort of the particular corpo-
ration.
The plaintiffs in their separately filed claims for re-
funds maintained that in order to fairly measure the tax-
able business income of each unitary member, a unitary
method of apportionment should have been applied. They
argued that under this formula, which they asserted was
authorized under section 304(a) of the Illinois Income Tax
Act, each corporation’s in-State, i.e., Illinois, data for its
property, payroll and sales should have been compared
C4
with the combined worldwide totals of the entire unitary
group, which included the plaintiffs and 21 other corpo-
rate subsidiaries of Caterpillar Tractor. The plaintiffs, in
their State returns, compared only the in-State totals of
each corporation with the in-State and out-of-State totals
for property, payroll and sales of the same corporation and
not of the unitary business group.
The plaintiffs argued that the unitary method of ap-
portionment should be applied for each of the plaintiffs
for the years 1970 through 1974 but not as to 1969. The
basis for excluding 1969 was the contention that the uni-
tary method of reporting did not accurately reflect the
amount of taxable income for that year since the Illinois
Income Tax Act did not take effect until August of 1969
(Ill. Rev. Stat. 1969, ch. 120, par. 1—101 et seq.). The
proposed application by the plaintiffs of the unitary
method of apportioament, and the claimed deductions for
dividend income, subpart F income, and foreign income
taxes paid, were denied by the Director. Timely protests
were filed by the plaintiffs.
At the later administra‘ive hearing, the plaintiffs in-
troduced extensive evidence showing a strong integrated
relationship between Caterpillar Tractor, the parent cor-
poration, and its multistate and multinational subsidiaries.
Based on this and on a strict policy of Caterpillar Tractor
to maintain worldwide uniformity in all phases of its
operations, including production, marketing and employer-
employee relationships, all of which were kept subject to
the central control of the parent corporation, the plaintiffs
contended that they should be considered members of a
unitary business group. The Director agreed and then
applied a unitary apportionment formula under section
304 of the Illinois Income Tax Act (Ill. Rev. Stat. 1977,
ch. 120, par. 3—304), using the combined worldwide busi-
C-5
ness income of Caterpillar Tractor and its 25 subsidiaries
in order to determine the appropriate percentage of busi-
ness income attributable to Illinois for each corporate
plaintiff for all six years in question, 1969 through 1974.
The Director, however, denied the deductions claimed for
the foreign income taxes, the deemed dividend income and
the subpart F income.
The plaintiffs appealed to the circuit court of Peoria
County (Ill. Rev. Stat. 1977, ch. 120, par. 12—1201) on
the ground that unitary apportionment should not have
been applied to their 1969 taxable income and on the ground
that the Director erred in denying the various deductions
claimed. The circuit court allowed the petitions of 16
corporations, including the Coca Cola Company, to inter-
vene, but limited intervention to the issue of whether uni-
tary apportionment is authorized under the Illinois Income
Tax Act (Ill. Rev. Stat. 1977, ch. 120, par. 1—101 et seq.).
The circuit court subsequently held that combined re-
porting was authorized in Illinois and affirmed the Direc-
tor’s decision to combine the worldwide income of Cater-
pillar Tractor and its 25 subsidiaries for purposes of
apportioning each plaintiff’s Illinois taxable income for
1970 through 1974. With respect to 1969, it held that the
unitary method of apportionment was, in general, inap-
plicable. The court held also that the plaintiffs could claim
as deductions dividend income, subpart F income, and also
foreign income taxes paid by foreign subsidiaries.
The appellate court, on appeals by the plaintiffs, the
Director, and the intervenors, affirmed the judgment as to
the application of the unitary method for 1970-74 but
held that the unitary method of apportionment was appli-
cable for 1969. (77 Ill. App. 3d 90, 101.) The Court affirmed
also the allowance of the petitions to intervene. It, how-
ever, also reversed the circuit court’s allowance of the
C4
deductions claimed by the plaintitfs. We granted and con-
solidated petitions for leave to appeal filed by the plaintiffs,
the Director and the intervenors and allowed the filing of
a number of amicus curiae briefs. The plaintiffs did not
seek an appeal from the holding that the unitary method
was to be applied to 1969. They did not seek an appeal
either from the appellate courts adverse holding as to
deducting dividend income and subpart F income.
We first address the issue of whether the trial court
erred, as the Director contends, in permitting the petitions
to intervene. The question of when a third party may
intervene is governed by section 26.1 of the Civil Practice
Act (Ill. Rev. Stat. 1979, ch. 110, par, 26.1). This section
provides that a party may intervene as a matter of right:
“(a) when a statute confers an unconditional right to
intervene; or (b) when the representation of the applicant’s
interest by existing parties is or may be inadequate and the
applicant will or may be bound by an order or judgment in
the action; or (c) when the applicant is so situated as to be
adversely affected by a distribution or other disposition of
property °**.” (Til. Rev. Stat. 1979, ch. 110, par.
26.1(1).) In the alternative, the court in its discretion may
permit intervention: “(a) when a statute confers a condi-
tional right to intervene; or (b) when an applicant’s claim
or defense and the main action have a question of law or
fact in common.” Ill. Rev. Stat. 1977, ch. 110, par. 26.1(2).
The circuit court, in permitting intervention, stated it
was being allowed as a matter of right and as a matter of
discretion. It refused, however, to address the question of
whether the intervenors were to he deemed to be con-
ducting unitary business operations.
The overall design of section 26.1 of the Civil Practice
Act was to liberalize the practice of intervention so as to
avoid, upon timely application, the relitigation of issues
C-7
in a second suit which were being litigated in a pending
action. (See Dowsett v. City of East Moline (1956), 8 Tl.
2d 560; Ill. Ann. Stat., ch. 110, par. 26.1, Joint Com-
mittee Comments, at 317-18 (Smith-Hurd (1968).) A party
need not have a direct interest in the pending suit but it
must have an interest greater than that of the general public
(see Mensik v. Smith (1960), 18 Ill. 2d 572-590; Cooper v.
Hinrichs (1957), 10 Tl. 2d 269, 270), so that the party may
stand to gain or lose by the direct legal operation and effect
of a judgment in the suit. In re Appointment of Special
State’s Attorneys (1976), 42 Ill. App. 3d 176, 181.
In their petitions for intervention (Ill. Rev. Stat. 1977,
eh. 110, par. 26.1(1)) before the circuit court, Coca Cola
and the 15 other corporate intervenors maintained that
the plaintiffs’ representation on the issue of whether the
Director may require the unitary method of apportionment
as a means to determine business income allocable to Illinois
as stated above would be inadequate, since the plaintiff only
challenged it use for the tax year 1969 and not for the years
1970 through 1974. The intervenors argue that the plaintiffs
have not raised on appeal any issue as to 1969, thus making
the necessity of intervention more urgent. The intervenors
currently are engaged in a similar dispute with the Director
as to whether the Director may determine their liability for
income tax using the combined income of their corporate
branches and subsidiaries or whether it must calculate the
tax, as the intervenors claim, based on separate corporate
returns. They also say that this appeal and the intervenors’
dispute before the Director involve a common question of
law, i.e., whether combined reporting is even authorized
under the Illinois Income Tax Act.
The Director contends that the intervenors’ position may
be fully protected by their appearance as amici curiae and
that intervention in this instance was improper. The Di-
C-8
rector argues that the intervenors, in actuality, are seeking
a declaratory judgment as to their rights under the [linois
Income Tax Act, which may not be granted unless they can
establish a right to injunctive relief. This relief, the Director
contends, citing Illinois Bell Telephone Co. v. Allphin
(1975), 60 Ill. 2d 350, 358-59, overruling Owens-Illinois Glass
Co. v. McKibbin (1943), 385 Ill. 245, which had provided an
exception in equity to the exhaustion rules, is not permitted
in a tax case unless a party has exhausted its administrative
remedies or has shown special circumstances to avoid this
requirement. The Director also maintains that the protest
act (Ill. Rev. Stat. 1979, ch. 127, par. 172) provides a means
to contest the Director’s position regarding the application
of the unitary apportionment method under the Illinois Tax
Act without the necessity of exhausting administrative
remedies. The Director says, too, that the Illinois Admin-
istrative Procedure Act (Ill. Rev. Stat. 1977, ch. 127, par.
1001 et seq.) dues not allow intervention at the administra-
tive level since to do so would permit a taxpayer to circum-
vent the protest act.
We do not consider the intervenors to be seeking a
declaratory judgment. The declared purpose of the inter-
vention is to raise the questions whether a unitary method
of apportionment is authorized and whether it may be re-
quired. The resolution of these issues will not necessarily
decide the intervenors’ disputes with the Director regard-
ing claimed tax deficiences. Furthermore, were this court
to hold that unitary apportionment is authorized under
the Illinois Income Tax Act, that holding would not decide
whether each of the 16 corporations may properly be
regarded as a unitary business group so that this method
of apportionment might be applied. The contention of the
Director that to permit intervention here would open an
avenue for taxpayers to “evade” the protest tax act does
C-9
not persuade. Intervention under section 26.1 of the Civil
Practice Act is not granted as a matter of course. Where
one has satisfied the burden to intervene as a matter of
right or where a court has not abused discretion in allow-
ing intervention there should be no arbitrary denial of it.
(See L.S. Health & Sons, Inc. v. Marathon Oil Co. (1977),
56 Ill. App. 2d 440.) The circuit court did not abuse dis-
cretion when it granted the petition for intervention. We
need not decide if intervention was to be allowed as a
matter of right. See Mensik v. Smith (1960), 18 Ill. 2d
572; Standard Bank & Trust Co. v. Village of Oak Lawn
(1978), 61 Ill. App. 3d 174.
We consider now the question the intervenors raise as
to whether the provisions of the Dlinois Income Tax Act
(Ill. Rev. Stat. 1979, ch. 120, par. 1-101 et seq.) authorize
the Director to use the unitary apportionment or combined
method of reporting business income for Illinois income
tax purposes. The [Illinois Income Tax Act became effec-
tive on August 1, 1969, and was held constitutional by this
court in Thorpe v. Mahim (1969), 43 Ill. 2d 36. The plain-
tiffs filed income tax returns for the years 1969 through
1974 and, as stated above, they later filed separate claims
for refunds for almost $11,000,000 covering this six-year
period. It was the Director’s agreeing with the plaintiffs
that Caterpillar Tractor and all of its subsidiaries should
be considered a unitary business group and further that
the combined method of apportionment should be applied
in order to determine the percentage of income attributable
to Illinois activities for each corporate plaintiff that led
the intervenors to seek to enter the case. They sought to
present their contention that the Illinois Income Tax Act
does not provide for reporting as a member of a unitary
business group and authorizes only the reporting of the
separate taxable income of a corporation through returns
C-10
filed under section 203(d)(2)(E) of the Illinois Income Tax
Act (Ill. Rev. Stat. 1977, ch. 120, pur. 2—203(d)(2)(E)).
This section provides that where “a member of an affiliated
group of corporations [files] a consolidated income tax
return for the taxable year for federal income tax pur-
poses * * *,” the Director shall determine taxable income
“as if such corporation had filed a separate return for
federal income tax purposes for the taxable year and each
preceding taxable year for which it was a member of an
affiliated group.” They erroneously claim that this section
shows a legislative intent to bar the unitary or combined
reporting method.
There are two basic methods of accounting used by State
tax officials to determine net taxable income in such a way
as to avoid the constitutional problems which arise when a
State attempts to tax that portion of a corporation’s busi-
ness income which clearly has been earned in other States
or countries. The first method, called separate accounting,
attempts to segregate and identify the sources or trans-
actions which account for the generation of business in-
come. This attempt to isolate the income-»roducing sources
becomes extremely complex in the case of business trans-
actions where members of a unitary business group located
in different States, and even countries, contributed to the
completion of the business transaction. Even where a uni-
tary operation has attempted to identify and separate the
contributions of each member to the completed transaction
and the generation of income by using a separate account-
ing method, there have been difficulties. The Supreme Court
has pointed out that “while it purports to isolate portions
of income received in various States, [separate accounting]
may fail to account for contributions to income resulting
from functional integration, centralization of management,
and economies of scale.” (Mobil Oil Corp. v. Commissioner
of Tawes (1980), 445 U.S. 425, 438, 63 L .Ed. 2d 510, 521,
C-11
100 S. Ct. 1223, 1232.) The court went on to say that “it
becomes misleading to characterize the income of the busi-
ness as having a single identifiable ‘source.’ Although sep-
arate geographical accounting may be useful for internal
auditing, for purposes of state taxation it is not constitu-
tionally required.” (445 U.S. 425, 438, 63 L. Ed. 2d 510, 521,
100 S. Ct. 1223, 1232.) (See also Hellerstein, State and
Local Taxation, 400 (3d ed. 1969); Dexter, “The Unitary
Concept in State Income Taxation, 10 Urb. Law. 243
(1978).) Recently the Supreme Court in Exon Corp. v.
Wisconsin Department of Revenue (1980), U.S. .
65 L. Ed. 2d 66, 100 S. Ct. 2109, held that where a State
has enacted an apportionment statute, the existence and
use by a company of an internal auditing or accounting
method did not bind the State to employ the same tech-
nique for computing taxable income.
The other method of accounting, which was applied
by the Director here, and which has been described, is
the combined or unitary apportionment method of re-
porting. In order to apply this method to the tax returns
of a corporate taxpayer, it must first be determined that
it is a member of a unitary business group. As was briefly
discussed, the term “unitary business group,” when ap-
plied to a corporation which has subsidiaries or other
associated corporations in other States or countries, is
used to describe a group of functionally integrated cor-
porate units which are so interrelated and interdependent
that it becomes relatively impossible for one State to
determine the net income generated by a particular cor-
poration’s activities within the State and therefore allo-
cable to that State for purposes of taxation. A classical
example of a unitary business is the Caterpillar Tractor
Company. This corporation, with its national and inter-
national subsidiaries, forms a network of companies whose
combined operations make Caterpillar Tractor the world’s
C-12
largest construction ar.d earthmoving manufacturer. Cater-
pillar Tractor and its 25 subsidiaries employ over 82,000
individuals at locations around the world. Its net world-
wide income for the taxable years 1969 through 1974
was calculated by the Director to be $1.8 billion. Despite
the magnitude and diversity of these multistate and multi-
national operations, there is an overriding corporate de-
sign to maintain strict uniformity in areas such as product
design, control maintenance, accounting procedures, re-
search and development and even a uniform standard or
code of the conduct for its personnel throughout the world.
Any suggested changes or departures from these uniform
procedures are subject to final approval from the corpo-
ration’s principal headquarters in Peoria.
In determining whether the Illinois Income Tax Act
authorizes and, indeed requires, as the Director contended
and as the appellate court held, combined reporting for
unitary business groups, we must analyze the legislative
history of this and other related income tax acts both
before and after the Illinois Income Tax Act became effec-
tive in August of 1969. In the “Official Commentary on
the Illinois Income Tax Act” which was issued by the
Department of Revenue shortly after the Act’s effective
date, it is stated under the discussion of article 3: “Article
3 of the Act provides rules for the allocation and appor-
tionment of business and non-business income between
Illinois and other states. For the most part this is accom-
plished by embodying * * * the principles of the Multi-
state Tax Compact which was adopted by Illinos effec-
tive July 1, 1967. At present 16 States (including Illinois)
have adopted this Compact and 11 other States are associ-
ate members. Adoption of the provisions of the Compact
was believed desirable in the interests of interstate uni-
formity and consistency with existing Illinois law.” Ill.
C-13
Tax Rptr. (CCH), par. 18—000, at 1901; par. 18—006, at
1903; par. 18—023, at 1911.
The first major attempt in promoting uniformity among
the States with respect to taxing interstate business was
the drafting and adoption of the Uniform Division of
Income for Tax Purposes Act (UDITPA). UDITPA was
incorporated into article IV of the Multistate Tax Com-
pact (MTC) (IIL Rev. Stat. 1973, ch. 120, par. 871 et seq.)
and as stated in the Official Commentary cited above, the
MTC became effective in Illinois on July 1, 1967. The ques-
tions before us now are: (1) whether UDITPA authorizes
the use of the unitary method of apportionment; and (2)
if it does, whether this method has been incorporated into
the Illinois Income Tax Act.
Considering whether UDITPA authorizes the use of
unitary apportionment, we first observe the UDITPA does
not make any reference to unitary apportionment or com-
bined reporting. The absence of specific reference to the
unitary method is not, however, critical, for in a number
of jurisdictions that adopted UDITPA and in some of
them, the MTC as well, courts have held that unitary appor-
tionment or combined reporting was authorized through
the particular income tax statute made no reference to this
method of reporting. In Coca Cola v. Department of Reve-
mue (1975), 271 Or. 517, 533 P.2d 788, the Oregon Depart-
ment of Revenue applied a unitary or combined apportion-
ment method of accounting to the income tax returns of
the plaintiff -orporation and its wholly owned subsidiaries,
which had filed separate returns using Oregon’s three factor
apportionment formula, which is similar to that set out in
the IZinois statute. The Department argued that the com-
bined method, though not specifically provided for in the
tax statutes into which UDITPA had been incorporated,
would more accurately reflect the income of what it con-
C-14
tended was a unitary business operation. Concluding that
the company’s syrup and bottling operations were so in-
extricably connected as to constitute a unitary business, the
court stated: “The combined method of apportionment
reporting is wholly consistent with, and a natural extension
of, the apportionment method.” (271 Or. 517, 528, 533 P.2d
788, 793.) The court held that the plaintiff and its sub-
sidiaries “are all part of the same unitary operation and
were required to use the combined method of reporting
for the tax years in question.” 271 Or. 517, 529, 533 P.2d
788, 794. See also American Smelting & Refining Co. v.
Idaho State Tax Com. (1979), 99 Idaho 924, 592 P.2d 39;
Montana Department of Revenue v. American Smelting ¢
Refining Co. (1977), 173 Mont. 316, 567 P.2d 901.
The Supreme Court has also held that the absence of
any statutory reference to the unitary method of reporting
does not forbid its use. In Butler Brothers v. McColgan
(1942), 315 U.S. 501, 86 L. Ed. 991, 62 S. Ct. 701, the
plaintiff, an [llinois corporation conducting a wholesale
goods and general merchandise business, was licensed to
conduct business in California. The company had whole-
sale distributing divisions located in seven states, including
California, each serving a district area and each controlling
its own sales force, accounting procedures, sales operations
and credit and financing procedures as well. Though the
California tax statute did not specifically authorize the
combined method of reporting or make any references to
unitary operations, the court upheld the State’s decision to
apply the unitary method to the combined income derived
from the operations of the seven divisions. In its holding
the court stated that “this Court has recognized that unity
of the use and management of a business which is scattered
through several states may be considered when a State
attempts to impose a tax on an appointment basis. As
stated in Hans Rees’ Sons, Inc. v. North Carolina, [ (1931),
C-15
283 U.S. 123, 133, 75 L. Ed. 879, 905, 51 S. Ct. 385,
389], ‘the enterprise of a corporation which manufactures
and sells its manufactured product is ordinarily a unitary
business, and all the factors in that enterprise are essential
to the realization of profits.’” 315 U.S. 501, 508, 86 L.
Ed. 991, 996, 62 S. Ct. 701, 704-05.
In a later case, Northwestern States Portland Cement
Co. v. Minnesota (1959), 358 U.S. 450, 3 L. Ed. 2d 421,
79 S. Ct. 357, the court addressed a similar challenge to
the use of a unitary apportionment method, and in citing
Hans Rees’ and other apportionment decisions (e¢.g., Bass,
Radcliff @ Gretton, Lid. v. State Tax Com. (1924), 266
U.S. 271, 69 L. Ed. 282, 45 S. Ct. 82; Underwood Type-
writer Co. v. Chamberlain (1920), 254 U.S. 113, 65 L.
Ed. 165, 41 S. Ct. 45) the court upheld the use declaring:
“These cases stand for the doctrine that the entire net
income of a corporation, generated by interstate as well as
intrastate activities, may be fairly apportioned among the
States for tax purposes by formulas utilizing in-state
aspects of interstate affairs.” 358 U.S. 450, 460, 3 L. Ed.
2d 421, 428, 79 S. Ct. 357, 363. See also Exxon Corp. v.
Wisconsin Department of Revenue (1980), US.
, 65 L. Ed. 2d 66, 100 S. Ct. 2109; Mobil Ow Corp.
v. Commissioner of Taxes (1980), 445 U.S. 425, 63 L.
Ed. 2d 510, 100 S. Ct. 1223.
The intervenors contend that even though the legis-
lature adopted UDITPA, and thus may have authorized
combined reporting, when it enacted article IV of the
MTC, UDITPA was not made a part of the Illinois Income
Tax Act. To support this argument, the intervenors main-
tain that when Illinois withdrew from participation on the
Multistate Tax Commission and repealed the Multistate
Tax Compact in 1975, it repealed UDITPA as well and,
as a result, there no longer is authority in Dlinois for the
C-16
combined or unitary apportionment method. That Illi-
nois withdrew from the Multistate Tax Commission in
1975, however, did not mean that the authority to use
the unitary method was also terminated. An examination
of various relevant provisions of UDITPA, the MTC,
and the Illinois Income Tax Act shows that the language
in each pertaining to the allocation and apportionment
of business income is very similar and in some instances
virtually identical. For example, the term “business in-
come” is defined in section 1501(a)(1) of the Illinois
Income Tax Act (Ill. Rev. Stat. 1979, ch. 120, par.
15—1501(a)(1)) im language, except for one additional
sentence not concerned in this case, identical to the
language used in section 1(e) of UDITPA and article IV,
section 1(a), of the MTC to define the same term. An
example of even greater significance and persuasiveness
is that the three-factor apportionment formula of sales,
property and payroll in the Illinois Income Tax Act,
apart from some minor change not relevant here, is iden-
tical to the formula set out in UDITPA which, as we
apart from some minor change not relevant here, is iden-
tical to the formula set out in UDITPA which, as we
have alreday determined, authorizes the use of the unitary
method. Considering that these provisions taken from
UDITPA are part of the Illinois Income Tax Act and that
the official commentary on the Act states that the rules
for allocation and apportionment under sections 301
_ through 307 of the Act (Til. Rev. Stat. 1979, ch. 120, pars.
3—301 through 3—307) have embodied the principles
underlying article IV of the MTC, which is UDITPA, it is
clear that the use of the combined or unitary apportion-
ment method is authorized under the Act and could be
required by the Department in the case of unitary business
groups. The purpose of this method as has been said, is to
permit the fair determination of the portion of business
C-17
income that is attributable to business activity in Illinois
by the reporting member of the unitary group. The con-
cern, it is emphasized, is in making a fair determination
of tax liability. This is why the legislature provided that if
the calculation of liability made by using the combined or
unitary reporting method does not accurately and fairly
represent the taxable business activity in Illinois, under
section 304(e) of the Illinois Income Tax Act the taxpayer
may petition that another method of determination be
used. Ill. Rev. Stat. 1979, ch. 120, par. 3—304(e).
The intervenors say that if the combined method of
reporting is required under the [Illinois Income Tax Act, its
imposition will be contrary to the decision in Japan Line,
Ltd. v. County of Los Angeles (1979), 441 U.S. 434, 60 L.
Ed. 2d 336, 99 S. Ct. 1813, which, they argue, held that
the combining of worldwide income for purposes of State
taxer‘on was unconstitutional. There, a Japanese shipping
company challenged an ad valorem property tax imposed
upon certain types of containers which were within the
State on March 1, the tax lien date in California. The
containers also were subject to a property tax in Japan
under the law of that country. The Supreme Court said
that the issue was “whether instrumentalities of commerce
that are owned, based, and registered abroad and that are
exclusively in international commerce, may be subjected
to apportioned ad valorem property taxation by a State.”
(441 U.S. 434, 444, 60 L. Ed. 2d 336, 345, 99 S. Ct.
1813, 1819.) The court was concerned with whether the
California tax scheme resulted in multiple taxation of
foreign commerce and therefore constituted an impermis-
sible instrusion into an area which the court described as
one that was “preeminently a matter of national concern.”
(441 U.S. 434, 448, 60 L. Ed. 2d 336, 347, 99 S. Ct.
1813, 1821.) The court, in holding that the tax was
C-18
invalid, judged that, first, the tax scheme “produce[d]
multiple taxation in fact” and, second, it prevented “this
Nation from ‘speaking with one voice’ in regulating foreign
trade.” (441 U.S. 434, 452, 60 L. Ed. 2d 336, 350, 99 &.
Ct. 1813, 1823.) This was especially true since Japan and
the United States had entered into an agreement entitled
“Customs Convention on Containers,” which was designed
to prevent the imposition of all duties and taxes upon con-
tainers deemed “instruments of international traffic”
(19 U.S.C. sec. 1322(a) (1976)) which were imported into
the United States on a temporary basis.
Japan Line is obviously distinguishable from the case
here. The purpose of the apportionment formula is to con-
fine the taxation of business income to that portion which
is attributable to activities in Illinois. This appeal dves not
involve the multiple texation of items or instrumentalities
of foreign commerce nor does unitary reporting affect
Federal authority in governing foreign commerce. The
concern here is only with the taxation of business income
fairly attributable to activities within the taxing State. See
Mobil Oil Corp. v. Commissioner of Taxes (1980), 445
U.S. 425, 63 L. Ed. 2d 510, 100 S. Ct. 1223; Complete
Auto Transit, Inc. v. Brady (1977), 430 U.S. 274, 51 L.
Ed. 2d 326, 97 S. Ct. 1076; Northwestern States Portland
Cement Co. v. Minnesota (1959), 358 U.S. 450, 3 L. Ed.
2d 421, 79 S. Ct. 317.
The intervenors’ argument that the unitary reporting
method violates due process also fails to persuade. In
Ezaon Corp. v. Wisconsin Department of Revenue (1980),
US. , 65 L. Ed. 2d 66, 100 S. Ct. 2109, the
Supreme Court considered the issue of whether a State, in
applying its method of formulary apportionment to a
corporate taxpayer’s total corporate income, violates the
due process clause where the corporation employs a func-
C-19
tional separate accounting method to separate the sources
of income so as to reflect its claimed division of opera-
tions. In upholding Wisconsin’s apportionment statute and
the decision of the Department of Revenue that the corpo-
ration’s Wisconsin marketing division was an integral unit
of its unitary operation, the court stated: “The Due Proc-
ess Clause of the Fourteenth Amendment imposes two
requirements for such state taxation: a ‘minimal connec-
tion’ or ‘nexus’ between the interstate activities and the
taxing State, and ‘a rational relationship between the
income attributed to the State and the intrastate values
of the enterprise’” ( US. , , 65 L. Ed. 2d 66,
79, 100 S. Ct. 2109, 2118). The nexus requirement is
satisfied if the State tax is imposed upon a company which
has availed itself of the privilege of conducting business
within the State. (Wisconsin v. J.C. Penney Co. (1940), 311
U.S. 435, 85 L. Ed. 267, 61 S. Ct. 246; Bass, Ratcliff &
Cretton, Ltd. v. State Taz Com. (1924), 266 U.S. 271, 69
L. Ed. 282, 45 S. Ct. 82; Underwood Typewriter Co. v.
Chamberlain (1920), 254 U.S. 113, 65 L. Ed. 165, 41 S. Ct.
45.) Illinois has a statute to this effect. Ill. Rev. Stat. 1979,
ch. 120, par. 2—201.
In next examining whether a rational relationship exists
between the business income claimed by the State for activ-
ities within the State and the actual value of the taxpayer’s
intrastate activities, the courts have looked to the reason-
ableness of the method used in attempting to determine
fairly the level of income generated by business operations
within the State. (See Butler Brothers v. McColgan (1942),
315 U.S. 501, 506-07, 86 L. Ed. 991, 995-96, 62 S. Ct. 701, 704.
See also Exxon Corp. v. Wisconsin Department of Revenue
(1980), US. , 65 L. Ed. 2d 66, 100 S. Ct. 2109;
Mobil Oil Corp v. Commissioner of Taxes (1980), 445 U.S.
425, 63 L. Ed. 2d 510, 100 S. Ct. 1223). We consider that
C-20
the overall design of section 304 is calculated to determine
that amount of business income fairly attributable to LIli-
nois. (Hans Rees’ Sons v. North Carolina ex rel. Maxwell
(1931), 283 U.S. 123, 75 L. Ed. 879, 51 S. Ct. 385.) That such
a formula may include income dervied from international
activities is not of consequence in determining whether the
statute satisfies the requirements of due process. See Mobil
Oi Corp. v. Commissioner of Taxes (1980), 445 U.S. 425,
63 L. Ed. 2d 510, 100 S. Ct. 1223; Bass, Ratcliff é Gretton,
Ltd. v. State Tax Com. (1924), 266 U.S. 271, 69 L. Ed. 282,
45 S. Ct. 82. See also United States Steel Corp. v. Multistate
Taa Com. (1978), 434 U.S. 452, 54 L. Ed. 2d 682, 98 S. Ct.
799.
The other arguments presented by the intervenors
against recognition of the combined apportionment method
of filing are not convincing. The intervenors contend that
the prohibition in Illinois against the filing of a consolidated
return (Ill. Rev. Stat. 1977, ch. 120, par. 2—203(d)(2)(E))
demonstrates a legislative intention to prohibit the use of
this method of reporting. We consider that the appellate
court correctly stated that the ban on filing consolidated
returns in Illinois was “irrelevant to a determination of
whether the unitary method of apportionment is to be used
in [inois.” (77 Ill. App. 3d 90, 99.) That Illinois does not
permit the filing of consolidated returns does not mean that
it therefore prohibits the use of the unitary apportionment
method. In permitting the filing of a consolidated tax return,
Federal law only requires that an affiliated group of cor-
porations meet certain stock ownership requirements which
show interrelationship among the corporations. (26 U.S.C.
sec. 1504(a) (1976).) Whether this group may also qualify
as a unitary business group is irrelevant to the determina-
tion of whether it may file a consolidated Federal income
tax return. The purpose of the combined method is solely
C-21
to permit an accurate determination of income attributable
to and taxable by Illinois in the case of a member of a
unitary business group.
Finally, the intervenors’ citation of a 1975 Illinois Tax
Bulletin (ITIB 1975—1) as support for its argument that
unitary reporting was proscribed upon repeal of the MTC
is misleading. The 1975 bulletin is entitled: Withdrawal of
Bulletin [TIB 1974—1 Relating to Combined Reporting for
Unitary Business. The quotation from this 1975 bulletin,
upon which the intervenors rely, is that “combination, as a
method of reporting unitary business income, is not author-
ized.” This 1975 bulletin was prematurely issued after the
MTC was repealed and at a time when it was not known
what changes in the Illinios Income Tax might follow. There
were amendments passed in 1975 but they did not affect
section 304 or any of the rules relating to allocation and
apportionment, which, as we have observed above, allow
the combined or unitary method of reporting. This was
made clear in a second bulletin issued in 1975, ITIB 1975—2,
which declare: “Repeal of the Compact provisions has no
substantive effect on current allocation and apportionment
provisions of the Illinois Income Tax Act.”
We turn now to a question raised by the plaintiffs. It
is whether domestic corporations, which elected to claim a
tax credit on their Federal returns for income taxes paid
to foreign governments, could have deducted the amount
of these foreign taxes from the taxable incomes reported
on their Illinois returns. Under the Internal Revenue Code,
a domestic corporation which has paid foreign income taxes
has the option of claiming a tax credit under sections 901
and 960 of the Code (26 U.S.C. secs. 901, 960 (1976)), or
taking a deduction under sections 164(a) and 275(a). (26
U.S.C. sees. 164(a), 275(a) (1976).) The plaintiffs argue
that they were entitled to claim a deduction on their State
C-22
returns for these taxes peid to foreign governments regard-
less of whether they claimed a tax credit or a deduction
on their Federal income tax returns.
The Director disagrees, saying that if a domestic corpo-
ration elected to take a tax credit on its Federal return for
foreign income taxes paid, as oppoced to claiming a deduc-
tion from taxable income, it is bound by this election for
State tax purposes and may not deduct these foreign tax
payments from the amount of Federal taxable income re-
ported on the State tax return.
We consider that the Director’s statement is correct. The
taxpayer had the election of taking a tax credit or a deduc-
tion on its Federal return. The election was binding. It
would not be permitted to take a tax credit to reduce the
Federal tax liability and also take a deduction from the
Federal taxable income reported on the State return so as
to reduce State taxable income. (Albany International Corp.
v. Halperin (Mrine 1978), 388 A.2d 902; Commonwealth v.
Westinghouse Eiectric Corp. (1978), 478 Pa. 164, 386 A.2d
491.) Moreover, #s we will next discuss, Illinois did not
permit corporations to claim a deduction for the payment
of foreign taxes until 1975 and the plaintiffs had a right
only to deductions specifically authorized under the Illinois
Income Tax Act. See Ill. Rev. Stat. 1977, ch. 120, par.
2-203(g).
The plaintiffs make another contention regarding the
payment of foreign taxes. They argue that foreign taxes
paid by a foreign subsidiary of a domestic corporation in a
unitary group are deductible by the domestic corporation
on its Illinois tax return when computing the combined
income of the unitary group. Section 203(b) of the Ilinois
Income Tax Act provides:
“(1) In general. In case of a corporation, base in-
come means an amount equal to the taxpayer’s taxable
C-23
income for the taxable year as modified by para-
graph (2).
(2) Modifications. The taxable income referred to in
paragraph (1) shall be modified by adding thereto the
sum of the following amounts:
. * o
(D) * * * and by deduction from the total so
obtained the sum of the following amounts:
eee
(F) An amount equal to any amount included
in such total under Section 78 of the Internal
Revenue Code * * *.” (Ill. Rev. Stat. 1977, ch. 120,
par. 2-203(b).)
It is of course true that the effect of section 203(b) as
applied through section 78 of the Internal Revenue Code is
to allow a domestic corporation to claim under the Illinois
Income Tax Act a deduction for foreign taxes paid by its
foreign subsidiary. This provision, however, did not be-
come effective unti! January 1, 1975. A corporation could
qualify for this deduction only in 1975 and thereafter. The
tax returns involved in this case are for years prior to
1975, and therefore the plaintiffs did not qualify for the
deduction.
For the reasons given, the judgment of the appellate
court on the questions raised on this appeal is affirmed.
Judgment affirmed.
MR. JUSTICE SIMON took no part in the considera-
tion or decision of this case.
APPENDIX D
D-1
ILLINOIS SUPREME COURT
CLELL L. WOODS, CLERK
Supreme Court Building
Springfield, Ill. 62706
(217) 782-2035
March 27, 1981
Mr. William P. Sutter
Attorney at Law
One First Natl. Plaza, 52nd Fir.
Chicago, IL 60603
Nos. 52818 — Caterpillar Tractor Co., et al., appellees, vs.
52828 Daniel J. Lenckos as Acting Director of the
52903 [Illinois Department of Revenue, et al., ap-
Cons. _pellees (The Coca-Cola Company, et al., ap-
<= Appeal, Appellate Court, Third
District.
The Supreme Court today denied the petition for re-
hearing in the above entitled cause. Mr. Justice Simon
took no part.
Very truly yours,
Clell L. Woods
Clerk of the Supreme Court
APPENDIX E
E-1
ILLINOIS REVISED STATUTES
CHAPTER 120
ILLINOIS INCOME TAX ACT
AN ACT to impose a tax on the privilege of earning or
receiving income in or as a resident of the State of
Illinois.
P.A. 76-261, $1, eff. Aug. 1, 1969.
Be it enacted by the People of the State of Illinois, repre-
sented in the General Assembly:
ARTICLE 1. SHORT TITLE AND CONSTRUCTION
1-101. § 101. Short Title. This Act shall be known and
may be cited as the “Illinois Income Tax Act.”
1-102. § 102. Construction. Except as otherwise ex-
pressly provided or clearly appearing from the context, any
term used in this Act shall have the same meaning as when
used in a comparable context in the United States Internal
Revenue Code of 1954 or any successor law or laws relating
to federal income taxes and other provisions of the statutes
of the United States relating to federal income taxes as
such Code, laws and statutes are in effect for the taxable
year.
ARTICLE 2. TAX IMPOSED
2-201. §201. Tax Imposed. (a) In general. A tax
measured by net income is hereby imposed on every indi-
vidual, corporation, trust and estate for each taxable year
ending after July 31, 1969 on the privilege of earning or
receiving income in or as a resident of this State. Such tax
shall be in addition to all other occupation or privilege
taxes imposed by this State or by any municipal corpora-
tion or political subdivision thereof.
E-2
(b) Rates. The tax imposed by this section shall be—
(1) in the case of an individual, trust or estate, an
amount equal to 24% of the taxpayer’s net income for
the taxable year, and
(2) in the case of a corporation, an amount equal to
4% of the taxpayer’s net income for the taxable year.
2-202. § 202. Net Income Defined. (a) In general. For
purposes of this Act, a taxpayer’s net income for a taxable
year shall be that portion of his base income for such year
which is allocable to this State under the provisions of
Article 3, less the standard exemption allowed by section
204.
(b) Taxable years beginning before August 1, 1969. (1)
Net income for a taxable year which begins before August
1, 1969 and ends after July 31, 1969 shall be that amount
which bears the same ratio to the taxpayer’s net income for
the entire taxable year as the number of days in such year
after July 31, 1969 bears to the total number of days in
such year, unless the taxpayer elects to apportion net in-
come for such taxable year in the manner provided by |
paragraph (2).
(2) If the taxpayer so elects, in the case of a taxable
year beginning before August 1, 1969 and ending after
July 31, 1969, there shall be taken into account in computing
base income only those items earned, received, paid, in-
curred or accrued after July 31, 1969, and the standard
exemption provided by section 204 shall be limited to that
amount which bears the same ratio to the total exemption
allowable under such section (determined without regard
to this section) as the number of days after July 31, 1969 in
the taxable year bears to 365. The election provided by this
paragraph shall be made in such manner and at such time
as the Department may by forms or regulations prescribe,
E-3
but shall he made ont later than the due date (inelnding any
extensions thereof) for the filing of the return for the tax-
able year, and shall be irrevocable.
2-203. § 203. Base income defined.
(a) Individuals.
‘1) In general. In the case of an individual, base income
means an amount equal to the taxpayer’s adjusted gross
income for the taxable year as modified by paragraph (2).
(2) Modifications. The adjusted gross income referred
to in paragraph (1) shall be modified by adding thereto the
sum of the following amounts:
(A) An amount equal to all amounts paid or accrued
to the taxpayer as interest or dividends during the tax-
able year to the extent excluded from gross income in
the computation of adjusted gross income;
(B) An amount equal to 50% of the excess of the
net long-term capital gain for the taxable year over the
net short-term capital loss for such year, to the extent
deducted from gross income in the computation of ad-
justed gross income; and
(C) An amount eqnal to the amount of tax imposed
by this Act to the extent deducted from gross income
for the taxable year;
and by deducting from the total so obtained the sum of the
following amounts ;
(D) Any amount included in such total in respect of
any compensation (including but not limited to any
compensation paid or accrued to a serviceman while a
prisoner of war or missing in action) paid to a resident
by reason of being on active duty in the Armed Forces
of the United States and in respect of any compensa-
tion paid or accrued to a resident who as a govern-
mental employee was a prisoner of war or missing in
action, and im respect of any compensation paid to a
E-4
resident in 1971 or thereafter for annual training per-
formed pursuant to Sections 502 and 503, Title 32,
United States Code as a member of the Illinois Na-
tional Guard;
(E) An amount equal to all amounts included in
such total pursuant to the provisions of Sections 402(a),
402(c), 402(d), 403(a), 403(b), 405(d), 406(a) and
407(a) of the Internal Revenue Code, or included in
such total as distributions under the provisions of any
retirement or disability plan for employees of any
governmental agency or unit;
(F) The valuation limitation amount;
(G) An amount equal to the amount of any tax im-
posed by this Act which was refunded to the taxpayer
and included in such total for the taxable year; and
(H) An amount equal to all amounts included in such
tetal which are exempt from taxation by this State
either by reason of its Constitution or by reason of the
Constitution, treaties or statutes of the United States.
(b) Corporations.
(1) Im general. In the case of a corporation, base income
means an amount equal to the taxpayer’s taxable income for
the taxable year as modified by paragraph (2).
(2) Modifications. The taxable income referred to in
paragraph (1) shall be modified by adding thereto the sum
of the following amounts:
(A) An amount equal to all amounts paid or accrued
to the taxpayer as interest during the taxable year to
the extent excluded from gross income in the com-
putation of taxable income;
(B) An amount equal to the amount of tax imposed
by this Act to the extent deducted from gross income
in the computation of taxable income for the taxable
year;
E-5
(C) In the case of a regulated investment company
or real estate investment trust, an amount equal to
the excess of (i) the net long-term capital gain for the
taxable year, over (ii) the amount of the capital gain
dividends attributable to the taxable year; and
(D) In the case of a Western Hemisphere trade cor-
poration, China Trade Act corporation, or possessions
company described in Section 931(a) of the Internal
Revenue Code, an amount equal to the amount de-
ducted or excluded from gross income in the computa-
tion of taxable income for the taxable year on account
of the special deductions and exclusions (but in the case
of a possessions company, net of the deductions allo-
cable thereto) allowed such corporations under the
Internal Revenue Code.
and by deducting from the total so obtained the sum of the
following amounts:
(E) An amount equal to the amount of any tax
imposed by this Act which was refunded to the taxpayer
and ineleded in such total for the texable year;
(F) An amount equal to any amount included in
such total under Section 78 of the Internal Revenue
Code; and
(G) An amount equal to all amounts included in
taxable income as modified by subparagraphs (A), (>.
(C) and (D) which are exempt from taxation by this
State either by reason of its Constitution or hy reason
of the Constitution, treaties or statutes of the United
States.
(3) Special rule. For purposes of paragraph (2)(A),
“gross income” in the case of a life insurance company shal!
mean the company’s share of the gross investment income
for the taxable year.
(c) Trusts and estates.
(1) In general. In the case of a trust or estate, base in-
come means an amount equal to the taxpayer’s taxable
income for the taxable year as modified by paragraph (2).
E-6
(2) Modifications. Subject to the provisions of para-
graph (3), the taxable income referred to in paragraph (1)
sha)! be modified by adding thereto the sum of the following
amo ats:
(A) An amount equal to all amounts paid or accrued
to the taxpayer as interest or dividends during the tax-
able year to the extent excluded from gross income in
the computation of taxable income;
(B) An amount equal to 50% of the excess of the
net long-term capital gain for the taxable year over the
net short-term capital loss for such year, to the extent
deducted from gross income in the computation of tax-
able income ;
(C) In the case of (i) an estate, $600; (ii) a trust
which, under its governing instrument, is required to
distribute all of its income currently, $300; and (iii)
any other trust, $100, but in each such case, only to the
extent such amount was deducted in the computation of
taxable income ; and
(D) An amount equal to the amount of tax imposed
by this Act to the extent deducted from gross income
in the computation of taxable income for the taxable
year,
and by deducting from the total so obtained the sum of the
following amounts:
(E) An amount equal to all amounts included in such
total pursuant to the provisions of Sections 402(a),
402(c), 402(d), 403(a), 403(b), 405(d), 406(a) and
407(a) of the Internal Revenue Code or included in
such total as distributions under the provisions of any
retirement or disability plan for employees of any
governmental agency or unit;
(F) The valuation limitation amount;
(G) An amount equal to the amount of any tax im-
posed by this Act which was refunded to the taxpayer
and included in such total for the taxable year; and
E-7
(H) An amount equal to all amounts included in
taxable income as modified by subparagraphs (A), (B),
(C) and (D) which are exempt from taxation by this
State either by reason of its Constitution or by reason
of the Constitution, treaties or statutes of the United
States.
(3) Limitation. The amount of any modification other-
wise required under this subsection shall, under regulations
prescribed by the Department, be adjusted by any amounts
included therein which were properly paid, credited, or re-
quired to be distributed for the taxable year.
(d) Gross income; adjusted gross income; taxable in-
come.
(1) In general. Subject to the provisions of paragraph
(2) and subsection (b) (3), for purposes of this Section and
Section 802(b), a taxpayer’s gross income, adjusted gross
income, or taxable income for the taxable year shall mean
the amount of gross income, adjusted gross income or tax-
able income properly reportable for federal income tax
purposes for the taxable year under the provisions of the
Internal Revenue Code.
(2) Special rule. For purposes of paragraph (1) of this
subsection, the taxable income properly reportable for fed-
eral income tax purposes shall mean:
(A) Certain life insurance companies. In the case
of a life insurance company subject to the tax imposed
by Section 802 of the Internal Revenue Code, life in-
surance company taxable income ;
(B) Certain mutual insurance companies. In the
case of a mutual insurance company subject to the tax
imposed by Section 821(a) or (c) of the Internal Rev-
enue Code, mutual insurance company taxable income
or taxable investment income, as the case may be;
(C) Regulated investment companies. In the case
of a regulated investment company subject to the tax
E8
imposed by Section 852 of the Internal Revenue Code,
investment company taxable income;
(D) Real estate investment trusts. In the case of a
real estate investment trust subject to the tax imposed
by Section 857 of the Internal Revenue Code, real
estate investment trust taxable income;
(E) Consolidated corporations. In the case of a
corporation which is a member of an affiliated group
of corporations filing a consolidated income tax
return for the taxable year for federal income tax pur-
poses, taxable income determined as if such corporation
had filed a separate return for federal income tax pur-
poses for the taxable year and each preceding taxable
year for which it was a member of an affiliated group.
For purposes of this subparagraph, the taxpayer’s
separate taxable income shall be determined as if the
election provided by Section 243(b)(2) of the Internal
Revenue “ode had been in effect for all such years;
and
(F) Cooperatives. In the case of a cooperative
c
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