Amicus Curiae Brief — Amerada Hess Corp. v. Director, Division of Taxation, New Jersey Department of the Treasury

Cea,

Nos. 87-453 and 87-464 Supreme Court, U.S.

In The AUG 11 1968

Supreme Court of the Unite SRA BESS SRNR

October Term, 1988

Amerada Hess Corporation, et al.,

Appellants,

Director, Division of Taxation,

Appellee.

Texaco Inc. and Tenneco Oil Company,

Appellants,

Director, Division of Taxation,

New Jersey Department of the Treasury,

Appellee.

-.

. 4

On Appeals from the Supreme Court of New Jersey

A

wo

BRIEF OF AMICI CURIAE IN SUPPORT OF THE

APPELLEE BY THE STATE OF IOWA, AND THE STATES

OF CALIFORNIA, FLORIDA, GEORGIA, IDAHO,

MICHIGAN, MONTANA, NEW YORK, NORTH DAKOTA,

RHODE ISLAND, SOUTH CAROLINA AND WYOMING

a

id

THOMAS J. MILLER

Attorney General of lowa

*Harry M. GriGer

Special Attorney General

*Marcia Mason

Assistant Attorney General

Hoover State Office Building

Des Moines, lowa 50319

(515) 281-5846

*(Counsel of Record)

(Continued on inside cover)

|

LL

COCKLE LAW BRIEF PRINTING CO., (800) 225-6964

OR CALL COLLECT (402) 342-2831

Joun K. VAN De Kamp

Attorney General of California

1515 K Street, Suite 511

Sacramento, California 95814

(916) 324-5376

Rosert A. BUTTERWORTH

Attorney General of Florida

Department of Legal Affairs

The Capitol

Tallahassee, Florida 32399

(904) 487-1963

MICHAEL J. Bowers

Attorney General of Georgia

132 State Judicial Building

Atlanta, Georgia 30334

(404) 656-3300

James T. JONES

Attorney General of Idaho

State House, Room 210

Boise, Idaho 83720

(208) 334-2400

FRANK J. KELLEY

Attorney General of Michigan

Law Building

Lansing, Michigan 48913

(517) 373-1110

Mike GREELY

Attorney General of Montana

Department of Justice

Justice Building

Helena, Montana 59620

(406) 444-2026

RosBert ABRAMS

Attorney General of New York

New York Department of Law

The Capitol

Albany, New York 12224

(518) 474-8101

NicHOLas J. SPAETH

Attorney General of

North Dakota

State Capitol

Bismarck, North Dakota 58505

(701) 224-2210

James E. O’NEIL

Attorney General of

Rhode Island

72 Pine Street

Providence, Rhode Island

02903

(401) 274-4400

T. Travis MEDLOCK

Attorney General of

South Carolina

Post Office Box 11549

Columbia, South Carolina

29211

(803) 734-3970

Joserri B. MEYER

Attorney General of Wyoming

123 Capitol Building

Cheyenne, Wyoming 82002

(307) 777-7838

TABLE OF CONTENTS

Page

pe iii

INTEREST OF AMICI CURIAE.................... 1

a cae ee idensseescecsedsacevecsesecees 2

I,

II.

DENIAL OF WPT AS DEDUCTION IN CALCU-

LATING APPORTIONED STATE TAX ON OR

MEASURED BY NET INCOME DOES NOT

INHERENTLY RESULT IN EXTRATERRITORIAL

TAXATION IN VIOLATION OF THE DUE PRO-

CESS CLAUSE AND THE COMMERCE CLAUSE

A. A Nonproducing State’s Disallowance Of

WPT As A Deduction In Calculating A Uni-

tary Tax Base Composed Of Net Income Does

Not Create An Inherent Geographic Bias In

Favor Of The Nonproducing State .........

1. Appellants’ Claim Of Geographic Bias Is

Contradicted By The Unitary Business

SSE eT errr reer err rrieee

2. The WPT And The Windfall Profit Are

Directly Associated With Appellants’

Marketing Activities In New Jersey.....

B. Disallowance Of A Deduction For The WPT

Does Not Operate As A Tax On The Removal

Of Crude Oil From Out-Of-State Premises

And Does Not Violate The Nexus And Fair

Relationship Standards .....................

DISALLOWANCE OF A DEDUCTION FOR THE

WPT FROM THE CBT BASE DOES NOT IMPER-

MISSIBLY DISCRIMINATE IN VIOLATION OF

THE COMMERCE CLAUSE OR THE EQUAL

PROTECTION CLAUSE ..............ccccccees

10

15

il

TABLE OF CONTENTS-Continued

Page

A. The New Jersey CBT Does Not Impermissi-

bly Discriminate Against Out-Of-State Busi-

ness Operations, But Properly Treats

Producers Differently Than Non-Producers 19

B. Disallowance Of A Deduction For The WPT

Does Not Discriminate Against Interstate

Commerce Because It Does Not Favor Any

Comparable In-State Activity or Taxpayer.. 21

SP 460s ins cas cssvauawinreeacedoniweel 27

ili

TABLE OF AUTHORITIES

Page

Cases:

Atlantic Coast Line Railroad Company v.

Daughton, 262 U.S. 413 (1923)................. 4, 20

Bass, Ratcliff & Gretton, Ltd. v. State Tax Commis-

SO Ee GP OPO GUI oe o5n.s0k ececnsncadvieresi 13

Commonwealth Edison Co. v. Montana, 453 U.S.

Ne I cos cwh ae euiabes oudendeeeuschcsetes baceus 18

Complete Auto Transit, Inc. v. Brady, 430 U.S. 274

UME baka pahsecagd ves seudy ues cc eok es linia 15, 17

Container Corporation of America v. Franchise

Tax Board, 463 U.S. 159 (1983)........ 3, 4, 5, 6, 8, 9

Crocker National Bank v. McFarland Energy, Inc.,

140 Cal. App. 3d 6, 189 Cal. Rptr. 302 (2d Dist.

Wh 555 Se SdN haa hen MAAC hada e TL Canboraeesatiecas 16

Exxon Corp. v. Governor of Maryland, 437 U.S.

Ope WMS 45050 5h0 505004655050 s80 0b eeibanauue 25, 26

Exxon Corp. v. Wisconsin Dept. of Revenue, 447

Va BOF SUMED soc scecseess 5, 7, 13, 14, 16, 18, 19, 22

Hans Rees’ Sons v. North Carolina, 283 U.S. 123

SUS vin nediees Sediere buesenuvehenesve caueaeh elas 9

Mobil Oil Corp. v. Commissioner of Taxes, 445

Se ee EE 40.5.0. 5.05 000404505 Fh conan eandveden 4,5

Moorman Manufacturing Company v. Bair, 437

eG I cd bncevivebastaesckveevs 4, 6, 8, 9, 19

Regan v. Taxation With Representation, 461 U.S.

OF EE aiinnunediansns ei ddeaeeeedbns Owens 16

Shell Oil Co. v. Bair, 417 N.W.2d 425 (lowa 1987) ....24

iv

TABLE OF AUTHORITIES-Continued

Page

Cases:

Shell Oil Co. v. New York State Tax Com‘n, 91

A.D.2d 81, 458 N.Y.S.2d 938 (1983).............04. 21

Tenneco West, Inc. v. Marathon Oil Co., 756 F.2d

Fe DE WI 5 64h s sav oveuneeeeseseuses 16, 17

Underwood Typewriter Co. v. Chamberlain, 254

ods cinch vausniesnaedeendeskecnnnes 4

United States v. Ptasynoski, 462 U.S. 74 (1983)...... 10

STATUTES:

EE sin kb nencceee Vineactnsabansaseneenen’ 24

ING anckcues su sdessneseswaauecetiesdens 12

I bcc secenudadscenshedareaeeuesess 11

ee errr rr ort reer rrr Tre 11

ED ins kh Atenas dh casacnendaeneneeee 12

I le caveuleeawev seetansuacs 12

nih oboe doch iuheenseenrenevasues 12

AE co pu saneeddeseNeussdeunewnedvunta 12

ee es IED dno 0-0.65:0.60.00ud snes enesssscenana 12

eG nt 5 oe cknns scunedeandnesasinapvasdas 12

eG 6 inet ee baesesecsweeneasenesne es 13

EE Shen ckd de edenerededesckses van anes 23

OTHER:

H.R.Rep.No.304,96th Cong.,2nd Sess.4 (1979) ........ 11

H.R.Rep.No.304,96th Cong.,2nd Sess.72 (1979) ....... 20

S.Rep.No.394,96th Cong.,2nd Sess.6 (1979)........... il

en cy

Vv

TABLE OF AUTHORITIES-Continued

Treas. Reg. § 1.471-116CMZMIM). .... 0. ce ccecesccees 24

125 Cong. Rec. H17141 (Remarks of Rep. Lederer) ....17

125 Cong. Rec. H17142 (Remarks of Rep. Shan-

BO Sats cs vcevuviendaiuecueuaceuevdesesigNnseeces 17

125 Cong. Rec. H17151 (Remarks of Rep. Ullman) ....17

INTEREST OF AMICI CURIAE

Pursuant to United States Supreme Court Rule 36,

the signatory States submit this Brief as Amici Curiae in

support of the Appellee. Since this Brief is sponsored and

filed by the aforementioned States, consent to its filing is

not required. United States Supreme Court Rule 36.4.

Some of the Amici States have significant oil produc-

tion while others have little or none. Some of the Amici

States disallow a deduction for the windfall profit tax in

the calculation of the State unitary net income base sub-

ject to apportionment. Others allow the WPT as a deduc-

tion. All Amici States employ the unitary business

principle in connection with their State taxes measured

by net income upon corporations.

All of the Amici States share a common concern

which has led to the filing of this Brief. Amici are con-

cerned that Appellants’ position that there is an inherent

geographic skewing of the unitary net income base in this

case unduly encroaches upon State use of the unitary

business principle. Amici strongly believe that a disal-

lowance of a cost, such as the WPT, in calculating net

income is related to the profitability of the unitary busi-

ness as a whole. To say otherwise, as Appellants do with

their argument that an inevitable geographic imbalance

occurs, would erode tire States’ ability to exercise a rea-

sonable discretion in defining a unitary net income base.

Appellants’ position is a blatant atter:pt to convince this

Court to sanction a separate accounting inroad to the

unitary business principle.

ARGUMENT

I. DENIAL OF WPT AS DEDUCTION IN CALCU-

LATING APPORTIONED STATE TAX ON OR

MEASURED BY NET INCOME DOES NOT

INHERENTLY RESULT IN EXTRATER-

RITORIAL TAXATION IN VIOLATION OF

THE DUE PROCESS CLAUSE AND THE COM-

MERCE CLAUSE.

Appellants make two basic arguments in this phase

of their Appeal. First, they contend that the New Jersey

Corporation Business Tax (CBT), by disallowing the fed-

eral windfall profit tax (WPT) as a deduction, creates a

geographic bias in the preapportionment net income base

so that the resulting apportionment will unreasonably

attribute net income to New Jersey. They claim that such

geographic imbalances must occur when the unitary net

income base includes receipts from the entire unitary

business but not all related costs, such as the WPT, which

they claim are incurred only outside the taxing State.

Second, they contend that the disallowance effectively

imposes the CBT as a windfall profit tax upon oil produc-

tion outside the State. The Solicitor General has filed a

brief in which he states that the New Jersey CBT raises

substantial federal questions with respect to denial of a

WPT deduction.

A. A Nonproducing State’s Disallowance Of WPT

As A Deduction In Calculating A Unitary Tax

Base Composed Of Net Income Does Not Cre-

ate An Inherent Geographic Bias In Favor Of

The Nonproducing State.

Appellants assume that the WPT is a site-specific cost

having nothing te do with New Jersey where no oil is

produced. They argue that the CBT cannot constitu-

tionally disallow the WPT as a deduction because there is

no comparable in-State outlay for which deduction is

disallowed in computing the CBT. “A taxing jurisdiction

is free to permit or deny deductions for such geograph-

ically dispersed costs without risk of creating an inher-

ently asymmetrical tax base.” (Appellants’ Brief at 22).

Amici contend that the alleged geographical bias is

contrived by Appellants. The application of the unitary

business principle effectively bars Appellants’ extrater-

ritorial taxation claims. In any event, a portion of wind-

fall profit is likely, as a matter of economic substance, to

be incurred in New Jersey so as to justify the WPT

deduction disallowance under Appellants’ theory of

deduction disallowance for geographically dispersed

costs.

1. Appellants’ Claim Of Geographic Bias Is Con-

tradicted By The Unitary Business Principle.

The unitary business/formula apportionment

method “calculates the local tax base by first defining the

scope of the ‘unitary business’ of which the taxed enter-

prise’s activities in the taxing jurisdiction form one part,

and then apportioning the total income of that ‘unitary

business’ between the taxing jurisdiction and the rest of

the world on the basis of a formula taking into account

objective measures of the corporation’s activities within

and without the jurisdiction.” Container Corporation of

America v. Franchise Tax Board, 463 U.S. 159, 165 (1983).

Although not unfettered, the States possess great leeway,

both in their definition of the scope of the unitary busi-

ness and in their choice of the apportionment formula.

Container, 463 U.S. at 164, 167.

The unitary net income base may include only uni-

tary operating net income of a single corporation, Under-

wood Typewriter Co. v. Chamberlain, 254 U.S. 113 (1920),

may include unitary operating net income and unitary

investment net income of a single corporation, Mobil Oil

Cor». v. Commissioner of Taxes, 445 U.S. 425 (1980), or may

include the unitary net income of all corporate affiliated

members of the unitary enterprise, Container Corporation

of America v. Franchise Tax Board, 463 U.S. 159 (1983). In

addition, the factor or factors in the apportionment for-

mula selected by the States need not be uniform among

the States. Moorman Manufacturing Company v. Bair, 437

U.S. 267, 278-280 (1978). Thus, a State may select from a

variety of methods to calculate the unitary net income

base or the apportionment formula, notwithstanding that

these methods inevitably attribute different increments of

income to the same income producing activities in the

State. These inevitable differences have not, by them-

selves, been held by this Court to result in extraterritorial

taxation.

Given that the unitary net income base subject to

apportionment need not be uniformly computed, it fol-

lows that the States have yreat leeway in their definition

of “net income” which constitutes that base. Indeed, in

Atlantic Coast Line Railroad Company v. Daughton, 262 U.S.

413, 422, n. 6 (1923), the Supreme Court observed with

respect to the makeup of the “net income” of a multistate

enterprise:

The term ‘net income’ i law or in economics has not

a rigid meaning. Every income tax act necessarily

defines what is included in gross income; what

deductions are to be made from the gross to ascertain

net income; and what part, if any, of the net income,

is exempt from taxation. These details are largely a

matter of governmental policy. As to them states

differ; and there is apt to be difference of view in the

same states at different times; and at the same time a

different definition of taxable net income for different

classes of taxpayers. Obviously, such differences in

detail do not render obnoxious to the commerce

clause a state income tax which is otherwise

unobjectionable.

Appellants, being unitary businesses, are unable to

demonstrate the precise sources of their net incomes

which are earned as a result of “functional integration,

centralization of management, and economies of scale”

which are “factors of profitability” that “arise from the

operation of the business as a whole.” Mobil Oil, 445 U.S.

at 438; Exxon Corp. v. Wisconsin Dept. of Revenue, 447 U.S.

207, 222 (1980). Therefore, attempts to match any cost

solely with a particular portion of a unitary business run

the risk of ignoring or capturing “inadequately the many

subtle and largely unquantifiable transfers of value that

take place among the components of a single enterprise.”

Container, 463 U.S. at 164-5.

Three cases run counter to Appellants’ site-specific

economic theory that the WPT must inherently be

allowed by a nonproduction State as a deduction in

determining net income of a unitary business to avoid a

geographic distortion of the tax base. In each case, this

Court rejected taxpayer arguments of unconstitutional

extraterritorial taxation and, instead, indicated a wide

leeway of tolerance for apportioned State taxes.

In Moorman Manufacturing Company v. Bair, 437 U.S.

267 (1978), this Court held that the Iowa single factor

sales formula did not inherently result in extraterritorial

taxation, even though that formula did not include the

property and labor of the taxpayer, whose Iowa activities

consisted of marketing its products which it manufac-

tured outside the State. The rationale in Moorman will not

support an argument that there is an inherent malappor-

tionment of net income associated with the taxpayer’s in-

State activities merely because the manufacturing compo-

nents, although included in the net income bas. as

deductions, for example, depreciation and payroll

expense, are not included as property and payroll factors

in the apportionment formula. In addition, this Court

noted the divergence in the definition of “nonbusiness

income.” 437 U.S. at 279. By analogy, it cannot be said

that a definition of net income which does not allow a

deduction of the WPT expense which is incurred by the

unitary business, so that it is functionally related to activ-

ities in the taxing State and elsewhere, violates the Con-

stitution by resulting in inherent extraterritorial taxation.

In Container Corporation of America v. Franchise Tax

Board, 463 U.S. 159 (1983), the taxpayer, in arguing

against an income apportionment upon a combined

report basis which included net income from foreign

subsidiaries, asserted tnat lower wages in foreign coun-

tries lead to lower costs of production there so that the

standard three factor formula, which included wages,

caused a geographical bias that unreasonably increased

income attributable to taxpayer’s operations in the taxing

State. The taxpayer’s evidence demonstrated such dis-

parity in wage rates and, further, that the lower foreign

wages were not balanced by lower foreign productivity

ievels. The Supreme Court rejected the argument that the

application of the standard three factor formula, under

these circumstances, created a geographical bias and dis-

torted result. This Court stated in 463 U.S. at 182:

The problem with all this evidence, however, is that

it does not by itself come close to impeaching the

basic rationale behind the three-factor formula.

Appellant and its foreign subsidiaries have been

determined to be a unitary business. It therefore may

well be that in addition to the foreign payroll going

into the production of any given corrugated con-

tainer by a foreign subsidiary, there is also California

payroll, as well as other California factors, contribut-

ing — albeit more indirectly — to the same production.

In Exxon Corp. v. Wisconsin Dept. of Revenue, 447 U.S.

207 (1980), the taxpayer alleged that its vertically inte-

grated oil business was subjeci to invalid extraterritorial

taxation by the taxing State of Wisconsin in which no oil

was produced. This Court rejected that allegation and

found a proper relationship “between the income attrib-

uted to the State by the apportionment formula and the

intrastate value of the business.” 447 U.S. at 227. In

Exxon, the taxpayer argued that Wisconsin was imposing

its tax upon the taxpayer’s production income that

occurred wholly outside the State. This Court rejected

that argument and treated the production activities as

contributing to the profitability of the whole unitary busi-

ness. Likewise, the WPT is associated with the prof-

itability of the entire unitary business. Therefore, Exxon

forecloses Appellants’ argument that a disallowance of a

deduction, even if constituting an out-of-State cost, inher-

ently results in extraterritorial taxation.

In the instant case, the alleged geographical distor-

tion caused by New Jersey’s refusal to allow Appellants

to deduct their WPT in the calculation of their unitary net

income bases is speculative. Since States are not rigidly

required to define a unitary net income base in a manner

which allows all costs to be deductible, New Jersey’s

refusal to authorize deduction of taxes imposed upon

income or profits is a perfectly reasonable exercise of the

State’s power to define its tax policy. To say otherwise

would be to introduce into the calculation of a unitary net

income base a rigidity that would not be warranted. New

Jersey has imposed a tax that, for all the record in the

instant case shows, is imposed upon “a rough approxima-

tion of a corporation’s income that is reasonably related

to the activities conducted within the taxing State.” Moor-

man, 437 U.S. at 273.

The importance to income production of each factor

in the three factor property-payroll-sales formula is by no

means ascertainable, so that giving each factor equal

weight is “arbitrary.” Container, 463 U.S. at 184, n. 20.

Indeed, it may very well be that the New Jersey market

place was “responsible for the lion’s share of the income

generated by” sales of Appellants’ products in New Jer-

sey. Moorman, 437 U.S. at 272. Certainly, nothing in the

record in this case disproves this potential fact and, if it

exists, there would be no geographical bias even if

Appellants’ theory as to the site-specific source of the

WPT had some merit.

Appellants’ geographical bias argument ignores the

function of the unitary business, formula apportionment

method which is an attempt to value the income produc-

ing activities of the unitary business in the taxing State.

This attempt passes constitutional muster as long as it

produces a result that is “reasonably related to the activ-

ities conducted within the taxing State.” Moorman, 437

U.S. at 273. In this regard, Appellants, in arguing that the

New Jersey failure to authorize a deduction of WPT

inherently results in extraterritorial taxation, seek to pre-

vail where previous State income tax litigants have

invariably lost. This Court has never held that a State

income tax unitary business/formula apportionment

method will always result in malapportionment. By con-

trast, this Court has made clear that Appellants’

unproven and speculative allegation is not enough to

show extraterritorial overreaching. Moorman, 437 U.S. at

272.

Instead, while overreaching has been occasionally

found in the application of the unitary method, Hans Rees’

Sons v. North Carolina, 283 U.S. 123 (1931), the taxpayer

has the heavy burden of showing by clear and cogent

evidence that an unreasonable apportionment or geo-

graphical bias has occurred in the application of that

method. Container, 463 U.S. at 164; Moorman, 437 U.S. at

274.

In the instant case, there is no “clear and cogent

evidence” that New Jersey’s failure to allew WPT as a

deduction in calculating net income has resulted in an

improper skewing of the value of Appellants’ income

10

producing activities in that State. The New Jersey deci-

sion to exclude the WPT as an allowable deduction

cannot support any assumption of unconstitutional geo-

graphic bias in State taxation, regardless whether Appel-

lants’ position has merit “from the standpoint of

economic theory or legislative policy.” Moorman, 437 U.S.

at 272. Therefore, even if the WPT were not imposed

upon an activity in New Jersey, there is no evidence in

this ca 2 that New Jersey’s refusal to authorize it as a

deduction automatically causes extraterritorial taxation

of Appellants’ income.

2. The WPT And The Windfall Profit Are Directly

Associated With Appellants’ Marketing Activ-

ities In New Jersey.

The WPT is a tax on additional or anticipated profits

which were expecied to accrue to the oil producers as a

result of decontrol of oil prices. In United States v.

Ptasynoski, 462 U.S. 74, 75-6 (1983), this Court stated:

During the 1970’s the Executive Branch regulated the

price of domestic crude oil. See HR Rep. No. 96-304,

pp. 4-5 (1979). Depending on its vintage and type, oil

was divided into differing classes or tiers and

assigned a corresponding ceiling price. Initially, there

were only two tiers, a lower tier for “old oil” and an

upper tier for new production. As the regulatory

framework developed, new classes of oil were

recognized.

In 1979, President Carter announced a program to

remove price controls from domestic oil by Septem-

ber 30, 1981. See id., at 5. By eliminating price con-

trols, the President sought to encourage exploration

for new oil and to increase production of old oil from

marginally economic operations. See HR Doc. No.

96-107, p. 2 (1979). He recognized, however, that

deregulating oil prices would produce substantial

gains (referred to as “windfalls”) for some producers.

il

The price of oil on the world market had risen mark-

edly, and it was anticipated that deregulating the

price of oil already in production would allow

domestic producers to receive prices far in excess of

their initial estimates. See ibid. Accordingly, the Presi-

dent proposed that Congress place an excise tax on the

additional revenue resulting from decontrol.

Congress responded by enacting the Crude Oil Wind-

fall Profit Tax Act of 1980, 94 Stat. 229, 26 USC § 4986

et. seq. (1976 ed, Supp V) [26 USCS §§ 4986 et. seq.].

The act divides domestic crude oil into three tiers

and establishes an adjusted base price and a tax rate

for each tier. See §§ 4986, 4989, and 4991. The base

prices generally reflect the selling price of particular

categories of oil under price controls, and the tax

rates vary according to the vintage and types of oil

included in each tier... .

(Emphasis supplied).

The Senate Report, concerning the proposed Windfall

Profit Tax Act, stated that the “committee believes that

the large price increases on previously discovered oil

resulting from phased decontrol are an appropriate object

of taxation.” S.Rep.No.394,96th Cong.,2nd Sess.6 (1979).

The House Report concurred by stating that “(t]he com-

mittee believes that there should be a tax on the windfall

from decontrol of crude oil prices and from excessive

increases in world prices.” H.R.Rep.No.304,96th

Cong.,2nd Sess.4 (1979).

The WPT is a tax “imposed on the windfall profit

from taxable crude oil removed from the premises during

each taxable period.” 26 U.S.C. § 4986(a). The WP1 is

“paid by the producer of the crude oil.” 26 U.S.C.

§ 4986(b).

The amount of WPT is imposed with respect to the

windfall profit for each “barrel of taxable crude oil.” 26

12

U.S.C. § 4987(a). There are three tiers of oil subject to the

WPT upon the windfall profit per barrel of integrated oil

companies and each tier has a different tax rate known as

“applicable percentage.” 26 U.S.C. § 4987(b).

The “windfall profit” is calculated by subtracting

from the “removal price” of a barrel of crude oil the

“adjusted base price” and the “severance tax adjustment”

with respect to that barrel. 26 U.S.C. § 4988(a). The

“removal price” of a barrel of oil is either its actual sales

price to third parties or a constructive sales price deter-

mined under 26 U.S.C. § 613. 26 U.S.C. § 4988(c). The

“adjusted base price” of a barrel of oil is its base price

multiplied by an inflation adjustment. 26 U.S.C. § 4989. In

determining the “windfall profit” of a barrel of oil, the

WPT Act provides that such “windfall profit” cannot be

in excess of “90 percent of the net income attributable to

such barrel.” 26 U.S.C. § 4988(b).

Structurally, the Congress opted to impose the WPT

upon a windfall profit per barrel of crude oil using in the

windfall profit calculation a “removal price” that was

either its actual sales price or its constructive sales price.

Obviously, integrated oil procucers, such as Appellanis,

who remove crude oil for sale off the production prem-

ises or who manufacture or refine products from their

extracted crude oil, whether on or off the production

premises, have not yet, by the mere act of “removal”,

recognized any profits or revenues as a result of decon-

trol of oil prices. That recognition will occur upon actual

sale of the crude oil or the refined and manufactured oil

products to third parties. The production activity is

merely one in a series of activities whereby the unitary

business actually earns the windfall profit that is subject

to the WPT.

13

The integrated oil producers transfer (remove) crude

oil from the production site to downstream facilities

where the oil is commingled with oil from other sources,

thereby making it impossible to trace any particular per

barrel windfall profit. However, when oil or oil products

emerge from downstream facilities and are sold in States,

such as New Jersey, it is reasonable to assume that the

artificially incurred windfall profit taxed by the WPT Act

upon “removal” is now realized and is earned, in pax, by

the integrated producers’ marketing activities in the

States where sold. Accordingly, the economic reality or

practical effect is that the windfall profit, resulting from

oil price decontrol, is earned, due to the unitary nature of

the business, “by a series of transactions beginning with

the [exploration and extraction of oil outside the State]

and ending in sales in [New Jersey] and other places.”

Bass, Ratcliff & Gretton, Ltd. v. State Tax Commission, 266

U.S. 271, 282 (1924); see Exxon Corp. v. Wisconsin Dept. of

Revenue, 447 U.S. 207 (1980).

It is reasonable to assume that some windfall profit

must be associated with sales of Appellants’ oil products

in New Jersey. But, it is impossible to ascertain the

amount thereof due to commingling of oil so that the per

barrel windfall profit cannot be traced to specific barrels

of oil that were consumied in the refining and manufac-

turing of products sold in New Jersey.! However, the fact

‘It is possible that some oil products sold in New Jersey

were refined from oil which was not associated with WPT,

either because the per barrel calculation was such that no

windfall profit was incurred or because the oi! was exempt

from the WPT, for example, oil from sources outside the

United States or oil exempt under 26 U.S.C. § 4991(b).

14

that Appellants, as integrated producer-mark iers, mar-

ket oil products in New Jersey assures that some windfall

profit is included in the sales prices of the refined oil

products and, as a result of their unitary business, is

earned in part in New Jersey.

When Appellants’ oil products are marketed in New

Jersey, one must assume that windfall profit is included

in the sales prices of such products. While Appellants

emphasize that the WPT is due upon “removal” even if

the oil is lost or otherwise never sold, the economic

reality remains that the WPT was imposed upon the

anticipated decontrolled revenues, in part due to Appel-

lants’ sales activities in New Jersey and elsewhere. The

structural form of the WPT should not disguise the prac-

tical substance that there is likely to be actual windfall

profit earned, in part, from Appellants’ activities in New

Jersey. It is unlikely that significant amounts of oil will be

lost or otherwise unsold. The “practical effect” of the

New Jersey CBT is controlling in this case. Exxon, 447

U.S. at 227-8.

For the WPT to be solely a site-specific cost, all

windfall profit must have accrued at the production site.

While windfall profit, namely, the additional revenue

from decontrol, may be site-specific if the crude oil is sold

to third parties at the production site, such site-specificity

does not occur where the integrated oil producers remove

crude oil to downstream facilities, as Appellants for the

most part did. Under those circumstances, while the

windfall profit is superficially deemed by Congress to

occur upon “removal” at the production site, the windfall

profit, in fact, cannot be deemed to solely accrue there.

The windfall profit will accrue, in part, as a result of

15

Appellants’ marketing activities of their oil products in

New Jersey and elsewhere wherein they sell those prod-

ucts which they refined and manufactured from their

extracted oil. Since the windfall profit, therefore, did not

accrue solely at the production site and at least a portion

of it accrued from marketing activities in New Jersey

where higher prices as a result of decontrol were

obtained, the WPT imposed 170n that geographically

dispersed windfall profit would not be sourced solely to

the production site. In practical effect, the WPT geo-

graphically follows the windfall profit. Accordingly, by

Appellants’ own geographically dispersed costs test for

State discretion to permit or deny deductions without

creating an inherent geographic imbalance, (Appellants’

Brief at 22), no such imbalance exists in this case.

B. Disallowance Of A Deduction For The WPT

Does Not Operate As A Tax On the Removal Of

Crude Oil From Out-Of-State Premises And

Does Not Violate The Nexus And Fair Relation-

ship Standards.

1. Appellants claim that disallowing a deduction

from the New Jersey CBT base for the federal WPT is the

same as imposing a New jersey windfall profit tax on the

out-of-State removal of oil. They claim that because New

Jersey has no nexus with the out-of-State removal of oil,

the disallowance of the deduction violates the nexus

prong of the test set forth in Complete Auto Transit, Inc. v.

Brady, 430 U.S. 274 (1977).

Disallowing a deduction, however, is not the equiva-

lent of imposing a tax. For example, if no deduction from

the income tax base is allowed for sales tax, the state has

not created another sales tax. If no deduction is allowed

16

for property tax, the State has not imposed a tax on the

taxpayer's property. If no deduction is allowed for a

severance tax, the State has not imposed a tax on

severance.

Deductions are a matter of grace and a form of

subsidy administered through the tax system which the

legislature can disallow as it chooses. Regan v. Taxation

With Representation, 461 U.S. 540, 544, 549 (1983). A State

is not required to allow deductions for expenses of doing

business, regardless of where those expenses may be

incurred. This includes tax expenses such as the WIT

“Income”, for State income tax purposes, need not be the

net income left for the use and enjoyment of the taxpayer.

New lersey in no way imposes a severance tax on

out-of-State severance. Liability for the New Jersey CbT

is not based upon the . nount of oil removed from the

ground or the value of t: oil. The apportionment for-

mula does not apportion b. ls of oil to New Jersey. It

apportions income. That incoi. > base may include a uni-

tary business’ total income. Exx. * Corp., 447 U.S. at 223.

That total income may constitutionally be the income

prior to payment of certain expenses, including the WPT

expense.

Appellants argue that disallowing a deduction for

the WPT acts as a severance tax because the WPT is a

severance tax. The WPT is not a severance tax, however.

lt is a tax on income or profits. Tenneco West, Inc. v.

Marathon Oil Co., 756 F.2d 769, 772-73 (9th Cir. 1985);

Crocker National Bank v. McFarland Energy, Inc., 140 Cal.

App. 3d 6, 189 Cal. Rptr. 302 (2d Dist. 1983). The WPT is

imposed upon excess revenue realized as a result of

17

decontrol. Tenneco West, 756 F.2d at 773. The fact that

liability for the tax is triggered by removal of the oil does

not make it a tax on removal. It is the vintage and type of

oil, and other factors specified in the Act, that determine

whether WPT is due. Id.? |

As previously discussed, the windfall profit is

earned, in part, as a result of Appellants’ New Jersey

marketing activities. There is no violation of the nexus

standard where New Jersey’s CBT disallows as a deduc-

tion a cost, such as the WPT, which is associated with

windfall profit activities in that State.

2. Appellants further argue that disallowing a

deduction from the New Jersey CBT base for the WPT

violates the fair relationship requirement of the Complete

Auto Transit test. They claim that New Jersey is imposing

a tax whose measure is a percentage of the value of the

crude oil produced is another state, thereby bearing no

relationship to the taxpayers’ presence or activities in the

State.

Appellants’ claim is groundless. The measu-e of the

New Jersey CBT remains income, with certain dea. .ctions

allowed. Since income results when the oil is sold, the

measure of the tax is related to Appellants’ marketing

activities in New Jersey. Appellants pay income tax to

2The fact that some members of Congress may have char-

acterized the WPT as a severance tax is irrelevant, especially

since other members recognized the WPT as being a tax on

profits. See 125 Cong. Rec. H17141 (Remarks of Rep. Lederer);

125 Cong. Rec. H17142 (Remarks of Rep. Shannon); 125 Cong.

Rec. H17151 (Remarks of Rep. Ullman).

18

New Jersey not because of out-of-State oil production but

because of their sales activities in New Jersey. In connec-

tion with thuse activities, New Jersey does afford protec-

tion and opportunities. Indeed, Appellants’ marketing of

oil is an integral part of their unitary businesses, impor-

tant to assure full use of their production and refining

operations. See Exxon Corp. v. Wisconsin Dept. of Revenue,

447 U.S. 207, 225-26 (1980).%

When a tax is assessed in proportion to a taxpayer’s

activities or presence in New Jersey, the taxpayer is

shouldering its fair share of supporting the State’s provi-

sion of police and fire protection services, a trained work

force, and the advantages of a civilized society. Common-

wealth Edison Co. v. Montana, 453 U.S. 609, 627 (1981).

Those advantages constitute a long list, including such

things as the maintenance of means of transportation and

the various amenities which encourage the use and con-

sumption of the products which directly add to Appel-

lants’ wealth.

’Appellants erroneously assert that the increased value of

crude oil due to decontrol bears no relationship to the pro-

ducer’s presence or activities in New Jersey. (Appellants’ Brie«

at 40). Without a market for the oil, however, the oil would

have no value. The presence of a New Jersey market for the oil

affects the oil’s value, including the value after decontrol.

Therefore, the increased value of oil due to decontrol is

directly related to the producers’ activities in New Jersey.

In addition, as discussed, supra, at pp. 10-15, the windfall

profit (and the WPT) are directly associated with New Jersey

activities. The practical effect of the CBT, in disallowing a WPT

deduction, is consistent with this association.

19

Appellants fail to prove that the disallowance of a

WPT deduction causes the New Jersey income tax to be

grossly out of proportion to the services provided by

New Jersey. This is especially true since New Jersey could

constitutionally tax Appellants’ New Jersey gross

receipts, which may well be a much larger tax base than

is the New Jersey net income base after apportionment.

Moorman Mfg. Co. v. Bair, 437 U.S. 267, 280 (1978); see

Exxon Corp. v. Wisconsin Dept. of Revenue, 447 U.S. 207,

227 (1980).

II. DISALLOWANCE OF A DEDUCTION FOR

THE WPT FROM THE CBT BASE DOES NOT

IMPERMISSIBLY DISCRIMINATE IN VIOLA-

TION OF THE COMMERCE CLAUSE OR THE

EQUAL PROTECTION CLAUSE.

Appellants claim that the disallowance of a deduc-

tion for the WPT violates the Commerce Clause and the

Equal Protection Clause because it imposes on crude oil

production activities, which occur outside of New Jersey,

a discriminatorily higher effective tax burden than that

imposed on in-State business activities. This claim is

unsupported by any comparison between similarly situ-

ated taxpayers or between comparable in-State and out-

of-State activities or taxpayers.

A. The New Jersey CBT Does Net !mpermissibly

Discriminate Against Out-Jf-State Business

Operations, But Properly Treats Producers Dif-

ferently Than Non-Producers.

Appellants are treated the same, for New Jersey CBT

purposes, as are all other corporations that pay the WPT.

They are not discriminated against in favor of other sim-

ilarly situated taxpayers. Producer-marketers of petroleum

are in fact different from nonproducer-marketers, as one

20

group directly benefited by the decontrol of oil prices and

one did not. Producer-marketers of petroleum received

the benefits of decontrol and higher oil prices which gave

rise to the windfall profits taxed by the federal govern-

ment. Nonproducer-marketers did not receive the bene-

fits of decontrol (since they had to purchase their oil at

the inflated prices) and accordingly paid no WPT. A State

legislature could reasonably conclude that corporations

paying WPT were in a better position to pay additional

state CBT due to their receipt of substantial windfall

profits which remained with these corporations even

after payment of the WPT. See H.R.Rep.No.304,96th

Cong.,2d Sess.72 (1979) (46 percent of unearned profits

left with oil producers).

Different businesses may be taxed on different bases

without violating the equal protection clause. The legisla-

ture may define “net income” as it sees fit as long as the

statute has a rational relationship to the legitimate legis-

lative purpose being accomplished. See Atlantic Coast Line

Railroad Co. v. Daughton, 262 U.S. 413, 423-25 (1923). It has

already been established that corporations receiving the

windfall profits from oil price decontrol are sufficiently

different from corporations who did not benefit from

decontrol to warrant different tax treatment. Producer-

marketers may constitutionally be classified differently

from other marketers of petroleum products. A state leg-

islature could reasonably conclude that producer-mar-

keters’ “corporate organization and the magnitude of

their operations in every aspect of the petroleum indus-

try, from the well to the gasoline pump, afforded [them] a

© ane AE

21

market power and economic advantage over their [non-

producer-marketing] competitors and special oppor-

tunities to obtain the benefit of the conditions existing in

the world-wide market.” Shell Oil Co. v. New York State

Tax Com'n, 91 A.D.2d 81, 458 N.Y.S.2d 938, 943 (1983).

“The equal protection clause does not prevent a state

from taxing such economic power and competitive

advantages.” Id.

B. Disallowance Of A Deduction For The WPT

Does Not Discriminate Against Interstate Com-

merce Because It Does Not Favor Any Compara-

ble In-State Activity Or Taxpayer.

1. Appellants agree that in disallowing a deduction

for the WPT the New Jersey CBT does not favor New

Jersey crude oil production. There is no tax burden

imposed on out-of-State transactions which is not

imposed on the same transactions conducted within the

State. This is not a case, for example, where out-of-State

depreciation or payroll is not allowed to be deducted

while the same in-State expenses are allowed as deduc-

tions. The disallowance of the WPT deduction by New

Jersey does not result in economic protectionism.

Appellants claim that New Jersey has singled out for

special tax burdens a business activity that is conducted

only in other states. They claim that they are “subjected

to disproportionate tax levies solely on account of their

business activities elsewhere.” (Appellants’ Brief at 44).

There is no evidence in the record to support the claim of

“disproportionate tax levies.” None of Appellants’ intra-

state marketing competitors have the financial advan-

tages of being an integrated producer-marketer “which

22

benefits from an umbrella of centralized management

and controlled interaction.” Exxon Corp. v. Wisconsin Dept.

of Revenue, 447 U.S. 207, 224 (1980). It is likely that, even

with the disallowance of a WPT deduction, Appellants’

expenses connected with doing business in New Jersey

are less than the expenses of intrastate nonproducer-

marketers. After all, the nonproducer-marketers must

purchase their products from producers who are going to .

charge the nonproducers an amount sufficient to return a

profit. Also, the producers are the ones who benefit from

the extra profits due to decontrol. There is no reason to

believe that the New Jersey CBT increases interstate mar-

keters’ cost of doing business in New Jersey over that of

intrastate marketers or imposes a disproportionate tax

burden on the interstate producer-marketers. The tax bur-

den may well be greater for the nonproducer-marketers.

Contrary to Appellants’ assertion, they are not

denied the deduction for the WPT “solely on account of

their business activities elsewhere.” (Appellants’ Brief at

44). They are not denied a deduction for the WPT because

they are engaged in interstate commerce or because they

are out-of-State companies. The nonproducer-marketers

who sell petroleum products in New Jersey are not neces-

sarily purely local businesses but may also be engaged in

interstate commerce. The denial of a deduction for the

WPT is not based upon the interstate nature of Appel-

lants’ businesses and does not burden out-of-State com-

panies, consumers, or transactions while favoring similar

in-State activities. The distinction is between producers

and nonproducers, and not between interstate and intra-

state marketers. No corporation which is denied a deduc-

tion for the WPT is denied such deduction because it

23

engages in interstate commerce, but because it produces

crude oil and pays the federally imposed WPT. If Appel-

lants were interstate marketers which were not also pro-

ducers of the oil they market, they would not be affected

by the disallowance of a WPT deduction. Furthermore, as

discussed above, the WPT is not related solely to out-of-

State activities but is related to Appellants’ marketing

activities in New Jersey.

Appellants’ argument regarding discrimination

against interstate commerce is based upon the false prem-

ise that, since there is no crude oil production in New

Jersey, there could be no New Jersey intrastate marketer

corporation which incurs WPT. However, the federal

WPT law imposes the WPT on any “holder of the eco-

mnemic interest with respect to the crude oil”, i.e., those

entitled to income from lifting the oil who thereby

received financial benefits from decontrol through higher

prices for their crude oil. 26 U.S.C. § 4996(a). The WPT is,

thus, imposed upon the New Jersey lessor of out-of-State

oil production wells.4 Nothing precludes an intrastate

corporate marketer from holding such an economic inter-

est and therefore being an oil “producer” as defined in

the WPT Act. Such an intrastate marketer would also be

denied a WPT deduction for CBT purposes.

4A New Jersey lessor of an out-of-State oil well can be an

intrastate marketer because a lessor need not receive the crude

oil or even be involved with oil production. The production

and ultimate disposal of the oil, under these circumstances, is

by the lessee. The lessor receives royalties as a result of pro-

duction. Nevertheless, the WPT is imposed upon the lessor.

24

a“

Appellants further complain that intrastate mar-

k: who purchase their oil products from integrated

oil producers are allowed to deduct their full cost of

goods sold, which may include a WPT element, while

integrated oil producers are not allowed to deduct the

WPT. However, this is also true of interstate marketers

who purchase oil products from integrated oil producers.

They may also deduct any WPT element which is passed

on to them in the sales price of the goods they purchase

and, therefore, is in their cost of goods sold. Whether the

WPT is nondeductible or excluded in the cost of goods

sold of a taxpayer, for New Jersey CBT purposes, is

wholly unrelated to whether the taxpayer is engaged in

interstate commerce.®

Moreover, the WPT is not imposed on marketers with

respect to oil products purchased from integrated oil

producers. The WPT is imposed upon the oil producers.

All marketers are entitled to exclude from their gross

incomes their cost of purchasing oil. That cost contains

many elements that integrated oil producers may choose

to include or to “pass on” to their customers. When

integrated oil producers, such as Appellants, purchase oil

from others who pay the WPT and if the purchase price

5Unlike other Amici States, lowa makes a distinction on

the basis of whether the producer included the WPT in its

inventory costs under 26 U.S.C. § 471 and Treas. Reg.

§ 1.471-11(c)(2)(iii) on its federal income tax return. Shell Oil

Co. v. Bair, 417 N.W.2d 425, 428-9 (lowa 1987). Such distinction

is unrelated to the interstate nature of the producer’s business.

Likewise, those States which do not make the Iowa distinction

have not disallowed the WPT deduction on the basis of inter-

state criteria.

ER

25

of the oil includes a WPT cost element, integrated oil

producers are likewise allowed, for New Jersey CBT pur-

poses, to exclude such purchase price from gross income.

The illustration set forth at pages 45-46 of Appel-

lants’ brief fails in its attempt to show that integrated oil

producers are taxed more heavily than the independent

marketers with which they compete. First, as discussed

above, the nonproducer’s cost of goods sold will likely be

greater than that of the producer, since the producer-

marketer will charge the nonproducer-marketer enough

to make a profit on the sale. Second, the tax burdens

should not be compared “per barrel of product sold in

New Jersey” (Appellants’ brief at 46), but based upon

income attributable to New Jersey. The groups being

compared are not taxed on barrels of oil sold in the State

but on income. Contrary to Appellants’ speculative asser-

tions, there is no proof that producer-marketers are at a

“material economic disadvantage”, bear a “higher effec-

tive tax cost” than the independent marketers, or pay

more than their “just share.” (Appellants’ Brief at 45, 47,

49).

The Commerce Clause is not violated when state

taxation affects a particular form of business organiza-

tion, as long as any distinction is not based upon the in-

State or out-of-State nature of the organization. In Exxon

Corp. v. Governor of Maryland, 437 U.S. 117 (1978), the

Court held that a Maryland statute did not discriminate

against interstate commerce in prohibiting the operation

of gasoline stations by companies which refined or pro-

duced crude oil. Since no oil was produced or refined in

Maryland, the statute prevented integrated oil producer-

marketers from operating their own gasoline stations in

26

the state while leaving gasoline stations operated by non-

integrated marketers unaffected. The Court pointed out

that the distinction was not between in-State and out-of-

State marketers, because several of the independent

retailers were in fact interstate marketers:

As the record shows, there are several! major inter-

state marketers of petroleum that own and operate

their own retail gasoline stations. These interstate

dealers, who compete directly with the Maryland

independent dealers, are not affected by the Act

because they do not refine or produce gasoline. In

fact, the Act creates no barriers whatsoever against

interstate independent dealers; it does not prohibit

the flow of interstate goods, place added costs upon

them, or distinguish between in-state and out-of-

state companies in the retail market. The absence of

any of these factors fully distinguishes this case from

those in which a State has been found to have dis-

criminated against interstate commerce. See, ¢.g.,

Hunt v. Washington Apple Advertising Comm'n, 432

U.S. 333, 53 L.Ed.2d 383, 97 S.Ct. 2434; ean Milk Co.

v. Madison, 340 U.S. 349, 95 L.Ed. 329, 71 S.Ct. 295.

For instance, the Court in Hunt noted that the chal-

lenged state statute raised the cost of business for

out-of-state dealers, and, in various other ways,

favored the in-state dealer in the local market. 432

U.S., at 351-352, 53 L.Ed.2d 383, 97 S.Ct. 2434. No

comparable claim can be made here. While the

refiners will no longer enjoy their same status in the

Maryland market, in-state independent dealers will

have no competitive advantage over out-of-state

dealers. The fact that the burden of a state regulation

falls on some interstate companies does not, by itself,

establish a claim of discrimination against interstate

commerce.

(Footnotes omitted). Exxon Corp. v. Governor of Maryland,

437 U.S. at 125-26.

27

New Jersey treats all corporations upon whom the WPT is

imposed exactly alike. This equality of treatment com-

pletely forecloses Appellants’ interstate commerce dis-

crimination claim.

o—

CONCLUSION

The judgment of the Supreme Court of New Jersey

should be affirmed.

Respectfully submitted,

THomas J. MiLi=R

Attornev General of lowa

Hoover State Office Building

Des Moines, Iowa 50319

Telephone: 515-281-5164

*Harry M. Gricer

Special Assistant Attorney General

*Marcia Mason

Assistant Attorney General

Hoover State Office Building

Des Moines, lowa 50319

Telephone: 515-281-5846

*(Counsel of Record)