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Supreme Court of Alaska
October 25, 2013
TESORO CORPORATION and Subsidiaries, Appellants,v.STATE of Alaska, DEPARTMENT OF REVENUE, Appellee.
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[Copyrighted Material Omitted]
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Mark Wilkerson, Wilkerson Hozubin, Anchorage, Gregory A. Castanias, Jones Day, Washington, D.C., and David E. Cowling and Roy T. Atwood, Jones Day, Dallas, Texas, for Appellants.
R. Scott Taylor, Senior Assistant Attorney General, Anchorage, Deborah J. Stojak, Assistant Attorney General, and Michael C. Geraghty, Attorney General, Juneau, and Louisiana W. Cutler, Jennifer M. Coughlin, and Serena S. Green, K & L Gates LLP, Anchorage, for Appellee.
Before: FABE, Chief Justice, CARPENETI, WINFREE, and STOWERS, Justices, and EASTAUGH, Senior Justice.[*]
EASTAUGH, Senior Justice.
Tesoro Corporation challenges income taxes assessed against it by the Alaska Department of Revenue (DOR) for 1994 through 1998. DOR calculated Tesoro's Alaska income by applying a three-factor apportionment formula to Tesoro's worldwide income, including that of its non-Alaskan subsidiaries. Tesoro challenged DOR's apportionment in a trial before an administrative law judge, who ruled that Tesoro was a unitary business that could be subject to formula apportionment, and that DOR could permissibly assess penalties against Tesoro. Tesoro appealed to the superior court, which affirmed.
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Tesoro argues here that only the income of its Alaska-based subsidiaries should have been subject to taxation in Alaska because Alaska's tax scheme violates the Due Process and Interstate Commerce Clauses of the United States Constitution. Because Tesoro's business was unitary, we reject Tesoro's challenge to the constitutionality of taxing all of its income under formula apportionment. Because Tesoro lacks standing to challenge the formula's constitutionality, we do not reach the internal consistency issue Tesoro raises. We also conclude that applying the formula to Tesoro satisfied the statutory requirement of reasonableness. Finally, we conclude that DOR permissibly imposed penalties on Tesoro. We therefore affirm the superior court decision that affirmed the administrative law judge's decision and order.
A. Tesoro's Business Activity
At relevant times, Tesoro Corporation was a petroleum company headquartered in San Antonio, Texas.[1] Tesoro had 33 subsidiary corporations that were organized into five business segments: (1) the Exploration and Production (E & P) segment based in Texas and Bolivia; (2) the Retail and Marketing (R & M) segment based in Alaska; [2] (3) the Marine Services segment based in Louisiana and Texas; [3] (4) the Corporate segment based in Texas; and (5) the Finance segment based in Texas.
Tesoro's board of directors had an active hand in shaping the financial, operational, and managerial decisions for Tesoro's subsidiaries. During the relevant period, the board met almost monthly to discuss and approve various aspects of the subsidiaries' operations. Furthermore, Tesoro's Corporate and Finance segments provided a number of administrative and financial services that were shared across all subsidiaries.
Two developments during the relevant tax years caused the companies within E & P to realize profits greater than those realized by the subsidiaries within R & M. In 1995 Tesoro sold part of its interest in a valuable natural gas field. And in 1996 Tesoro prevailed on a breach of contract claim and later that year sold its remaining interest in the same contract. Those events brought E & P nearly $200 million in revenue. Tesoro's appeal here effectively tries to shield the profits related to those events from taxation in Alaska.
B. Tesoro's Tax History In Alaska
In 1959 Alaska adopted the Uniform Division of Income for Tax Purposes Act (UDITPA).[4] UDITPA was drafted and approved by the National Conference of Commissioners on Uniform State Laws in 1957 in an attempt to bring uniformity to state tax codes.[5] In 1970 Alaska adopted the Multistate Tax Compact, which is a restatement of UDITPA with some minor changes.[6] The Multistate Tax Compact is codified at AS 43.19.010. Per AS 43.19.010, article IV, section 9, the portion of a business's total income apportioned to Alaska is determined by " multiplying the income by a fraction, the numerator of which is the property factor
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plus the payroll factor plus the sales factor, and the denominator of which is three." The property factor is the fraction of the taxpayer's total property and the property attributable to the taxpayer's business in Alaska; similarly, the sales and payroll factors are fractions of the taxpayer's respective total sales and payroll attributable to the taxpayer's business in Alaska.[7]
Alaska Statute 43.19.010, article IV, section 18 permits DOR to adjust a taxpayer's tax burden if the statutorily mandated apportionment does not " fairly represent the extent of the taxpayer's business activity in this state." Subsection 18(a) allows DOR to apportion the taxpayer's income based on separate accounting, while subsection 18(c) allows DOR to add " one or more additional factors" to the apportionment formula.[8] The statute effectively requires that any remedy DOR enforces under section 18 be " reasonable." [9]
Alaska Statute 43.20.144 modifies AS 43.19.010's apportionment scheme for all taxpayers " engaged in the production of oil or gas ... in this state or engaged in the transportation of oil or gas by pipeline in this state." [10]Alaska Statute 43.20.144(c) provides three different apportionment formulas for such taxpayers, depending on the nature of the taxpayer's oil or natural gas business in Alaska. Under AS 43.20.144(c)(1), a taxpayer that only transports oil or gas in Alaska is subject to a two-factor formula based on property and sales. Under AS 43.20.144(c)(2), a taxpayer that only produces oil or gas in Alaska is instead subject to a two-factor formula based on property and extraction. Finally, under AS 43.20.144(c)(3), a taxpayer that both transports and produces oil or gas in Alaska is subject to a three-factor formula based on property, sales, and extraction.
From the time it began doing business in Alaska in 1969 until 1994, Tesoro filed its tax returns as a unitary business. During this period all of Tesoro's corporate income was subject to taxation in Alaska, and the amount actually apportioned to Alaska was determined by the three-factor property, sales, and payroll formula of AS 43.19.010, article IV, section 9. In 1995 Tesoro purchased the Kenai Pipeline (KPL), the pipeline that serviced its Kenai-based refinery. As a result of this purchase, Tesoro became a taxpayer " engaged in the transportation of oil or gas by pipeline" in Alaska, and thus became subject to taxation under AS 43.20.144.
In its tax return for 1995 Tesoro took the position that KPL was not unitary with the remainder of Tesoro's business segments. Tesoro thus claimed that only KPL was subject to taxation under the two-factor property and sales formula specified by AS 43.20.144(c)(1), while Tesoro's remaining business segments were subject to taxation under the three-factor property, sales, and payroll formula specified by AS 43.19.010, article IV, section 9. This was the first time Tesoro had ever asserted in an Alaska tax return that its subsidiaries were not unitary with each other. In its tax returns for 1996 and 1997 Tesoro again took the position that KPL was not unitary with the remainder of Tesoro's subsidiaries. And in those returns Tesoro also asserted for the first time that its Finance segment was not unitary with the remainder of its subsidiaries and as such was not subject to taxation in Alaska at all.
On October 1, 1998, DOR completed an audit of Tesoro's tax returns for the years 1994 and 1995 and rejected Tesoro's position that KPL and the Finance segment were not unitary with the remainder of Tesoro's subsidiaries or each other. DOR's resulting assessment stated that " Tesoro is one unitary petroleum business" and that " the entire group is subject to modified apportionment under AS [43.20.144]." DOR accordingly apportioned all of Tesoro's business income under the two-factor property and sales formula of AS 43.20.144(c)(1) for nine months of 1995 to account for Tesoro's March 1995 purchase of KPL. DOR also disallowed the exemptions for Tesoro's foreign subsidiaries for this same nine-month period.
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After receiving this assessment, Tesoro filed its 1998 tax return in which Tesoro again asserted that KPL was not unitary with the remainder of Tesoro's business segments. This return also took the position that the subsidiaries within R & M were not unitary with the remainder of Tesoro's subsidiaries, including KPL.[11] Thus, this 1998 tax return treated only the R & M subsidiaries and KPL as subject to taxation in Alaska: KPL under AS 43.20.144(c), and the R & M subsidiaries under AS 43.19.010, article IV, section 9. In response, DOR conducted a second audit assessment of Tesoro's tax filings, this time for the years 1996, 1997, and 1998. In the resulting assessment, DOR rejected Tesoro's theory concerning the unitariness of Tesoro's business and reasserted that all of Tesoro's businesses were a single unitary group subject to AS 43.20.144.
But during the interval between DOR's first audit and its second, the Attorney General of Alaska issued an opinion calling into question the constitutionality of AS 43.20.144(c) as applied to businesses that produce oil or gas in state but transport it out of state.[12] In response, DOR issued an advisory letter on November 19, 1999 to all oil and gas taxpayers in Alaska; the letter stated that DOR would exercise its authority under AS 43.19.010, article IV, subsection 18(c) to fashion a remedy to the constitutional infirmity identified by the Attorney General. DOR's letter stated that this remedy would allow a taxpayer that both produced and transported oil or gas to use the three-factor property, sales, and extraction formula of AS 43.20.144(c)(3). The letter stated:
The department will follow the [Attorney General's] opinion and allow taxpayers to use the three-factor apportionment formula in these circumstances pursuant to the authority of AS 43.19.010 Art. 4, Sec. 18(c). Accordingly, an AS [43.20.144] taxpayer engaged both in the production of oil or gas from a lease or property in any jurisdiction and in the pipeline transportation of oil or gas in any jurisdiction may use an apportionment formula consisting of extraction, property and sales....
In its assessment for the years 1996, 1997, and 1998, DOR adhered to its November 19, 1999, letter and applied the three-factor formula of AS 43.20.144(c)(3) (hereinafter " the section 18 remedial formula" or " remedial formula" ) to Tesoro. DOR also assessed penalties against Tesoro for its repeated unwillingness to recognize KPL as unitary with Tesoro's other subsidiaries.
C. Past Proceedings
Tesoro first appealed the assessments for the years 1994 to 1998 during informal conferences with DOR; it next appealed in proceedings before an administrative law judge; it finally appealed to the superior court. The adjudicators at each stage agreed with DOR's initial assessment that Tesoro was a single unitary business during the relevant years; that the three-factor formula applied to Tesoro produced a constitutionally and statutorily fair apportionment of Tesoro's total income; and that Tesoro's conduct in filing its tax returns justified penalties.
Thus, Administrative Law Judge Mark T. Handley conducted a ten-day hearing at which Tesoro and DOR presented testimony from Tesoro employees and executives, DOR auditors, and expert witnesses familiar with Tesoro's business activities. The administrative law judge also reviewed hundreds of exhibits, including Tesoro's internal financial records, Tesoro's public financial filings, correspondence between Tesoro employees, and reports drafted by expert witnesses. In determining that Tesoro's subsidiaries were a unitary business for the relevant years, the administrative law judge made factual findings referring to the evidence and relied heavily on the testimony and reports of two of DOR's expert witnesses: Professors James Smith and Richard Pomp. The administrative law judge found these two witnesses to be " very persuasive," and stated that " these experts demonstrated an impressive understanding of Tesoro's organization and
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business activities." Both experts looked at evidence in the record and found Tesoro to have exhibited functional integration, centralized management, and economies of scale and thus found Tesoro's subsidiaries to be one unitary business. The administrative law judge found these witnesses were particularly persuasive as compared to Tesoro's witnesses, whom he found " less convincing" because he found Tesoro's witnesses tried to divert focus away from relevant facts and were dismissive of the relevant legal factors. By contrast, the administrative law judge found that Professors Pomp and Smith identified which facts in the record were significant and that these experts provided " strong, but objective, opinions" as to the import of these facts.
When Tesoro appealed to the superior court, Superior Court Judge Fred Torrisi affirmed the administrative law judge's decision. The superior court held that Tesoro was a unitary business, that the formula applied to it was not constitutionally unfair, and that penalties were justified. In its unitary-business holding, the superior court relied mainly on the factual findings of the administrative law judge and cited to the findings of shared administrative and financial services across Tesoro's subsidiaries.
Tesoro now appeals to us.
We review questions of law de novo, using our independent judgment.[13] We apply the substantial evidence standard of review to disputed questions of fact in administrative decisions.[14] In applying this standard, we will not re-weigh evidence or re-evaluate the fact finder's credibility determinations.[15] Whether Tesoro's business is unitary is a question of law that requires no agency expertise.[16] We will consider the issue de novo, giving only " some weight" to the agency's decision on the matter.[17] Determining the constitutionality of a given statute presents a question of law that we review de novo.[18] Statutory interpretation is also a question of law that we review de novo.[19] In its appeal regarding penalties, Tesoro appears to argue that as a matter of law it cannot be penalized for violating an unconstitutional statute. The penalties appeal therefore presents a question of law: whether Tesoro should have been excused from paying penalties because one aspect of the tax scheme under which it was penalized was unconstitutional. We review this question de novo.[20]
Tesoro asks us to review three issues on appeal: (1) whether the tax scheme applied by DOR violates the Due Process and Interstate Commerce Clauses of the United States
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Constitution; (2) whether the section 18 remedial formula is statutorily unreasonable; and (3) whether the penalties DOR assessed against Tesoro are invalid. We consider each issue in turn.
A. Tesoro's Constitutional Challenge To Formula Apportionment Fails.
Under the Due Process and Interstate Commerce Clauses of the United States Constitution, a state " may not tax value earned outside its borders." [21] The central inquiry is " whether the state has given anything for which it can ask return." [22] But the United States Supreme Court has long recognized that taxing multi-state companies using strict geographic accounting fails to account for " the many subtle and largely unquantifiable transfers of value that take place among the components of a single enterprise." [23] The unitary business/formula apportionment method of taxation is meant to remedy this problem.[24] Under this method, a taxing state first identifies the unitary business of which the taxpayer's in-state activities are a part and then apportions the income of this unitary business to the taxing state according to a set formula. [25] Tesoro challenges both the administrative law judge's finding that all of Tesoro's subsidiaries constituted a single unitary business and the administrative law judge's application of the three-factor apportionment formula of AS 43.20.144(c). We hold that Tesoro was a unitary business amenable to formula apportionment and that Tesoro lacks standing to contest the application of the AS 43.20.144(c) three-factor apportionment formula.
1. The administrative law judge did not err in finding Tesoro to be a single unitary business.
Tesoro bears the burden of proving by clear and cogent evidence that the state tax results in extraterritorial values being taxed.[26] In order for a business to be unitary, and thus amenable to formula apportionment, there must be flows of value between the parent and subsidiary.[27] The United States Supreme Court has distinguished these flows of value from the mere passive flow of funds that arises from any parent-subsidiary relationship.[28] Three " factors of profitability" indicate a unitary business: functional integration, centralization of management, and economies of scale.[29]
Tesoro argues that its involvement in its subsidiaries was the type of passive investor-investment relationship that exists between any parent and subsidiary. DOR counters that there were sufficient flows of value across Tesoro's business segments to justify the administrative law judge's finding of unitariness in this case.
Although Tesoro asserts that it is not disputing the administrative law judge's factual findings, it repeatedly makes assertions factually at odds with those findings. The administrative law judge heard ten days of testimony and reviewed more than 30,000 pages of documents. The administrative law judge also relied extensively on the report and testimony of Professor Smith, who reviewed much of the voluminous record before providing his expert opinion as to the nature of Tesoro's business. To the extent that Tesoro explicitly or implicitly challenges the administrative law judge's findings, we must determine whether substantial evidence supports
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those findings.[30] Applying the substantial evidence standard, we reject any challenge to the administrative law judge's factual findings. The administrative law judge relied on the facts discussed by Professor Smith because he found Professor Smith to be persuasive and the facts identified by Professor Smith to be relevant. By contrast, the administrative law judge found Tesoro's witnesses to be unconvincing, as they seemed to ignore the relevant facts in the record. Evidence in the record supports the facts reported by Professor Smith and found by the administrative law judge. It is not our place to re-weigh evidence or re-evaluate the credibility determinations of the administrative law judge.[31]
As we explain below, Tesoro has not carried its burden of proving the non-unitary nature of its business. The facts as found by the administrative law judge show that Tesoro's relationship with its subsidiaries fits within relationships that we and the United States Supreme Court have held to be unitary.
a. Tesoro's subsidiaries were functionally integrated.
Tesoro contends that the subsidiaries within the E & P and R & M segments were not functionally integrated because there was no overlap in any " actual function" between them. Tesoro admits that it provided its subsidiaries with shared administrative and financial services, but asserts that the absence of " synergistic operations" between the subsidiaries within E & P and R & M is fatal to finding functional integration.
The pertinent case law refutes Tesoro's restrictive interpretation of the functional integration concept. In Container Corp. of America v. Franchise Tax Board, the United States Supreme Court held a paperboard company to be unitary with its subsidiaries where the parent provided the subsidiaries with loans and loan guarantees, occasional assistance in obtaining equipment and fulfilling personnel needs, and general oversight and guidance.[32] In Alaska Gold Co. v. State, Department of Revenue, we upheld a finding of functional integration where the parent approved capital expenditures greater than $100,000, handled salaries and payroll for executives, and guaranteed the subsidiaries' lease obligations.[33] And in Earth Resources Co. of Alaska v. State, Department of Revenue, we upheld a unitary business finding where the parent provided the subsidiary with loans and loan guarantees, a uniform pay scale, salary guidelines, and a uniform retirement plan.[34] In each of these cases the courts examined the same sorts of administrative and financial services that Tesoro argues are irrelevant. In two of these cases there was little or no " operational synergy." [35]
Tesoro provided services to its subsidiaries to a greater degree than did the taxpayers in all of these cases combined. Like the taxpayers in Container Corp. , Alaska Gold, and Earth Resources, Tesoro provided its subsidiaries with both loans and loan guarantees. As the administrative law judge observed:
Tesoro's business segments jointly guaranteed major loans or " credit facilities" during the audit period. CEO [Bruce] Smith explained that the purpose of these credit facilities was to keep the entire corporation going and that the credit facilities were not dedicated to a particular business segment. Tesoro's central management used the funds obtained from the major credit facilities to finance purchases by individual subsidiaries as well as to provide working capital for general corporate purposes.
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The heads of R & M and E & P were not involved in obtaining financing to fund their operations because these functions were performed by CEO [Bruce] Smith, Mr. [William] Van Kleef and the corporate finance department.
(Footnotes omitted.)
In the portion of his report cited by the administrative law judge, Professor Smith noted that these credit facilities were secured using corporate-wide assets and that the funds were made available to the subsidiaries as needed.
Tesoro's involvement in financing the subsidiaries went beyond merely loaning money to the subsidiaries. As the administrative law judge explained:
Various bank accounts were used during the course of the audit period to receive customer remittances. However, at any one time, a single, shared bank account was used to receive remittances from customers of all the subsidiaries. Funds belonging to the respective subsidiaries were all directed to the same account so that these funds were available to fund the working capital needs of all Tesoro subsidiaries.
In the portion of his report cited by the administrative law judge, Professor Smith elaborated on how cash management was functionally integrated across subsidiaries. He explained that because Tesoro set overall limits on capital expenditures, capital investments made by one subsidiary had to be offset by investments in other subsidiaries.
Thus, Tesoro exercised near-complete control over the funding of subsidiary operations. Tesoro pooled customer remittances from all its subsidiaries into a shared bank account and then distributed this money back to the subsidiaries. There was evidence that local management had no knowledge or control of the sources of their operational funds. Furthermore, Tesoro controlled the capital investments made by each subsidiary and set an overall limit on capital investment across subsidiaries.
Like the taxpayers in Alaska Gold and Earth Resources, Tesoro also provided guidance on personnel matters. The administrative law judge found that Tesoro's human resources department provided uniform stock option plans, benefits, and salary guidelines across subsidiaries.
Moreover, like the taxpayer in Container Corp., Tesoro provided its subsidiaries with general oversight and guidance. As described in more detail below, the administrative law judge found that Tesoro's board of directors was active in overseeing operations of the subsidiaries. The Tesoro board reviewed and approved annual operating budgets, major expenses, and specific projects for the subsidiaries.
Tesoro's involvement with its subsidiaries went beyond what was held to be sufficient in the three cases cited above. The administrative law judge found that Tesoro also provided its subsidiaries with uniform services in the fields of environmental compliance and safety, information services and technology, internal auditing, legal affairs, insurance, risk management, purchasing, and accounting. These shared services refute Tesoro's assertion that its subsidiaries were not functionally integrated.
Tesoro argues that because its witnesses testified that the value of the administrative services it provided to its subsidiaries accounted for only a " trifling" one to two percent of its overall costs, these services do not indicate functional integration. But the administrative law judge did not credit the testimony Tesoro cites for this proposition; he instead found the value of the relevant services to be $100 million over the five audited years. Tesoro also contends that the administrative law judge, in calculating the flow of value created by these services, erroneously relied on the price Tesoro charged its subsidiaries for these services, rather than the difference between the price Tesoro charged and the price the subsidiaries would have been charged via arms-length transactions in the open market. Tesoro's view of the law would mean that had Tesoro charged its subsidiaries market prices for these shared services, there would have been no flow of value. But in Alaska Gold we stated that even if the goods and services provided by parent to subsidiary were priced " at prevailing
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market prices, they [were] nonetheless evidence that the companies were not acting independently." [36] Regardless, the administrative law judge did find that significant flows of value existed because he found that the prices Tesoro charged its subsidiaries for administrative and financial services did not accurately quantify the services' actual value.
Tesoro further argues that there was no functional integration across subsidiaries because, it asserts, each subsidiary had " autonomous local management that made all day-to-day decisions." This contention, even if factually correct, would not be dispositive. In Container Corp., the United States Supreme Court upheld a finding of functional integration even though the parent company handled only " major problems and long-term decisions" and " day-to-day management of the subsidiaries" was left to local management.[37]
b. Tesoro centrally managed its subsidiaries.
Tesoro argues that no centralized management existed during the relevant period because it had no major role in the operational matters of its subsidiaries. Tesoro instead presents itself as a mere financial overseer, responsible only for capital structure, major debt, and dividends.
But the administrative law judge found that Tesoro's role was in fact much broader than this. During the relevant period, all of Tesoro's subsidiaries were governed by Tesoro's very active board of directors. The administrative law judge found that Tesoro's board met frequently to make all major financial and operational decisions for the subsidiaries. In making this finding, the administrative law judge found relevant the testimony of two senior Tesoro executives who discussed how their operational expertise and management assistance benefitted E & P and R & M. Furthermore, in the portion of his testimony cited by the administrative law judge, Professor Smith estimated that Tesoro's board met almost monthly to discuss issues regarding the subsidiaries. By contrast, the administrative law judge found that the boards of the subsidiaries that comprised E & P and R & M never met during the relevant period and that these subsidiaries' boards instead acted by signing written consent resolutions handed down to them by Tesoro's corporate arm.
In the portion of his testimony cited by the administrative law judge, Professor Smith also gave examples of the specific projects that Tesoro's corporate board discussed and approved. Many of these were Alaska-based projects. For example, the Tesoro board discussed increasing the frequent-filler program at Alaskan Tesoro service stations, expanding Tesoro's asphalt sales in Alaska, upgrading the Girdwood service station, increasing home-heating sales in Fairbanks, and expanding the Alaskan hydrocracker plant and the effects that expansion would have on the jet fuel market in Anchorage. Tesoro was not a passive rubber-stamp of any independent decisions by the subsidiaries. For example, Professor Smith testified that in 1997 Tesoro's corporate board actually sent back the annual budget submitted by R & M and required revisions. This hands-on Tesoro involvement in Alaskan business refutes any claim that Tesoro's Alaska-based subsidiaries should have been treated as somehow insulated from the rest of Tesoro's business enterprise.
c. Tesoro's business exhibited economies of scale.
Tesoro argues that there were no economies of scale because the interaction between parent and subsidiaries during the taxing period represented flows of funds, not flows of value.
But the administrative law judge found that Tesoro experienced significant cost savings by providing its subsidiaries with centralized services instead of leaving each segment to source these services itself. In the portion of his report the administrative law judge cited for this proposition, Professor Smith observed that eliminating administrative redundancies and offering consolidated
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services saved Tesoro $2.24 million a year. Professor Smith further observed that this figure amounted to approximately 10% of the value of providing these services in total. The administrative law judge also found that providing these services created further unquantifiable flows of value by allowing local management to focus on day-to-day business operations without worrying about these administrative and financial matters.
Furthermore, in Earth Resources we upheld a finding that economies of scale existed because the subsidiary was able to receive financing at lower rates due to the parent's ability to negotiate lower interest rates for all subsidiaries than any subsidiary could have negotiated on its own.[38] Here the administrative law judge explicitly credited Professor Smith's testimony on the subject and found that Tesoro and its subsidiaries experienced approximately $30 million in interest savings over the five audited years through the use of shared credit facilities. In fact, in the cited portion of his testimony, Professor Smith explained that Tesoro Alaska was able to obtain commercial credit from BP for the shipment of crude oil only after Tesoro provided a letter of credit.
d. Tesoro's other arguments against a unitary finding are unpersuasive.
Tesoro asserts that the case most analogous to the facts here is F.W. Woolworth Co. v. Taxation & Revenue Department of New Mexico. [39] But we consider Woolworth to be distinguishable in every material respect. The United States Supreme Court held there that " no phase of any subsidiary's business was integrated with the parent's." [40] In so holding, the Court noted the absence of the very administrative and financial services present here.[41] Furthermore, in Woolworth the parent did not control subsidiary funds. Instead, each subsidiary " was responsible for obtaining its own financing from sources other than the parent." [42] Finally, in Woolworth the parent had no involvement in overseeing subsidiary operations.[43] Here Tesoro was active in overseeing subsidiary operations.
Tesoro also argues that vertical or horizontal integration is a necessary condition for finding a unitary business. Tesoro cites no case that affirmatively establishes this principle, but asserts that it must be true because no United States Supreme Court case denies it. Tesoro's position is problematic for two reasons. First, the United States Supreme Court has been reluctant to issue bright-line rules such as the one Tesoro proposes, saying instead that the mutual interdependence necessary for a unitary business finding can arise in " any number of ways." [44] Second, in Earth Resources we upheld a unitary business finding even where there was " no highly integrated flow of business between the business entities." [45] We decline Tesoro's invitation to overrule past precedent in order to enforce the negative, and unsupported, inference Tesoro would read into the case law. For these reasons, we hold that Tesoro was a single unitary business throughout the relevant period.
We recognize that one respected treatise has questioned our holding that the two businesses in Earth Resources constituted a unitary enterprise. [46]
We read that criticism to stem from the authors' opinion as to what
constitutes sound state tax policy, not the case-based requirements of the
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constitution.[47] Tesoro's appeal from DOR's unitary business finding turns only on federal constitutional grounds. There is no issue before us about whether a different tax policy would be preferable. The legislative and executive branches made the controlling policy choices. The only question for us in this case is whether those choices satisfy the federal constitution.
2. Tesoro lacks standing to challenge the internal consistency of Alaska's tax scheme because Tesoro does not demonstrate that it was injured by any inconsistency in this scheme.
Having affirmed the determination that Tesoro's subsidiaries constituted a single unitary enterprise, we must next address Tesoro's argument that the apportionment scheme applied by DOR was internally inconsistent and thus violated the Due Process and Interstate Commerce Clauses of the United States Constitution. As the United States Supreme Court stated in Container Corp.:
[A]n apportionment formula must, under both the Due Process and Commerce Clauses, be fair. The first, and again obvious, component of fairness in an apportionment formula is what might be called internal consistency— that is the formula must be such that, if applied by every jurisdiction, it would result in no more than all of the unitary business's income being taxed.[[48]]
The test for internal consistency posits a situation in which every jurisdiction applies the tax at issue; the test then determines whether under such circumstances more than 100% of the taxpayer's income would be subject to taxation.[49] The hypothetical situation envisioned by the internal consistency test is valuable because it allows courts to identify when " a State is attempting to take more than its fair share of taxes from the interstate transaction." [50] In applying this test, courts are attempting to prevent the taxing state from " overreaching" such that " the portion of value by which one State exceed[s] its fair share [is] taxed again by a State properly laying claim to it." [51]
Tesoro argues that Alaska's tax scheme is unconstitutional because it potentially applies two different formulas— either the section 18 property, sales, and extraction formula or the section 9 property, sales, and payroll formula— and thus could result in more than 100% of a taxpayer's income being taxed. Tesoro is correct that DOR's taxing scheme applies one of two different apportionment formulas depending on a taxpayer's in-state business activity. Per the terms of DOR's November 19, 1999 advisory letter, the section 18 remedial formula applies to any " AS [43.20.144] taxpayer" that both produces and transports oil or gas. But this formula only applies to a taxpayer that conducts at least one of these activities in Alaska, because AS 43.20.144
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only applies to such taxpayers.[52] Thus, a taxpayer that both produces and transports oil or gas anywhere and also does at least one of these activities in this state is taxed under the section 18 remedial formula that includes the property, sales, and extraction factors.[53] But a taxpayer that both produces and transports oil or gas but does neither of those activities in this state is instead taxed under the formula prescribed in AS 43.19.010, article IV, section 9 that includes the property, sales, and payroll factors.
DOR urges us to ignore this feature of Alaska's tax code and consider only the specific three-factor formula that it applied to Tesoro in Alaska, not the entire tax scheme that also contains a different formula that potentially applies, depending on which activities the taxpayer conducts in the taxing jurisdiction. DOR thus assumes, for purposes of determining consistency, that every jurisdiction taxing Tesoro would use the section 18 remedial formula. This assumption fails to recognize that jurisdictions where Tesoro neither produces nor transports oil or gas would instead tax Tesoro under the AS 43.19.010, article IV, section 9 formula. In effect, DOR would look narrowly at the formula it actually applied here rather than at the broader statutory scheme. This is not the test. In Armco Inc. v. Hardesty, the United States Supreme Court assessed an internal consistency challenge to a West Virginia tax scheme in which businesses that manufactured in state were subject to a manufacturing tax, businesses that sold goods at wholesale in state were subject to a wholesaling tax, and businesses that did both activities in state were exempt from the wholesaling tax but subject to the manufacturing tax. [54] The tax scheme was analogous to the one at issue in this case in that taxpayers were subject to different tax formulas depending on the extent of their in-state business activities.[55] A taxpayer that sold at wholesale in state but manufactured out of state challenged the constitutionality of West Virginia's scheme.[56] If DOR were correct, the United States Supreme Court should have scrutinized only " the formula actually used" for the taxpayer: the exemptionless wholesaling tax. It did not. The Court instead scrutinized the " precise scheme" and held that the scheme was internally inconsistent because under it taxpayers " from out of State [would] pay both a manufacturing tax and a wholesale tax while sellers resident in West Virginia [would] pay only the manufacturing tax." [57] The Court was specifically interested in the potential for differential application of the various formulas.[58] We therefore reject DOR's invitation to consider only the particular three-factor formula applied here; we instead look at the precise two-formula scheme at issue when evaluating Tesoro's internal consistency challenge.
On appeal, Tesoro bases its internal consistency argument on an example that illustrates the property, sales, extraction, and payroll factors for a hypothetical taxpayer that is amenable— as was Tesoro— to taxation in Alaska, Texas, and California. Per Tesoro's hypothetical example, the taxpayer is subject to the property, sales, and extraction formula in Alaska and Texas, and is subject to the property, sales, and payroll formula in California (where it neither produces nor transports oil or gas). The example's choice between different apportionment formulas causes 106.7% of the hypothetical taxpayer's income to be taxed in total. In its opening brief, Tesoro appears to argue that this hypothetical taxpayer bears no specific relationship to Tesoro. Tesoro there argues only that the example shows how DOR's proposed tax structure could result in double
Page 845
taxation if it were applied to " a business with production and/or pipeline activities outside but not inside Alaska." Tesoro was not such a business during the contested years because it owned KPL, an Alaska-based pipeline, and Tesoro did not otherwise assert that its hypothetical example in fact described Tesoro's actual situation. Although we reserve judgment on the issue, the only state to have reached the issue rejected a taxpayer's argument that internal inconsistency can be demonstrated by applying a tax scheme to a purely hypothetical taxpayer rather than the actual taxpayer.[59]
In its reply brief, Tesoro subtly refines its argument. It there contends that the example in its opening brief was meant to illustrate Tesoro's actual business situation and thus that the example showed that if all states adopted Alaska's tax scheme Tesoro " would face an unconstitutional apportionment of more than 100% of its income." [60] (Emphasis added.)
We will address arguments that a party has properly asserted and briefed and decline to address arguments that it has not.[61] The taxpayer bears the burden of establishing the internal inconsistency of the challenged tax statute.[62] Tesoro has alleged an internal consistency violation exclusively in context of the specific hypothetical facts set out in its example. Accordingly, we will address the internal consistency argument under the assumption that the information in the example is substantially similar to Tesoro's actual business situation. We consider Tesoro to have waived any other internal consistency challenge to Alaska's tax scheme.
Because Tesoro has not explained how it has been harmed by any internal inconsistency in Alaska's tax scheme, Tesoro lacks standing to raise its internal consistency argument. " Standing is a rule of judicial self-restraint based on the principle that courts should not resolve abstract questions or issue advisory opinions." [63] In order to have interest-injury standing, a plaintiff must have an interest adversely affected by the complained-of conduct.[64] Tesoro complains that DOR's tax scheme is constitutionally infirm because the scheme chooses between two different apportionment formulas. But Tesoro has not shown that it has been adversely affected by this choice. Instead, Tesoro's example demonstrates that DOR applied the formula that was more favorable to Tesoro. Its example states that the property, sales, and extraction formula allowed 46.7% of its income to be subject to taxation in Alaska. But its example also demonstrates that 65% of Tesoro's total income would have been subject to taxation in Alaska under the property, sales, and payroll formula.[65] The 6.7% of double
Page 846
taxation that Tesoro's example identifies is the amount by which California's hypothetical property, sales, and payroll apportionment would exceed California's hypothetical property, sales, and extraction apportionment. As footnote 65 indicates, in presenting its example, Tesoro has not demonstrated that the inconsistency it identifies has increased its tax burden in Alaska. Tesoro therefore lacks standing to raise its internal consistency claim because it has not identified an actual injury it has suffered as a result of the alleged constitutional infirmity.
Tesoro cites Armco v. Hardesty for the proposition that it need not show actual double taxation because the constitutional harm under the internal consistency test is the risk of double taxation.[66] In Armco, the United States Supreme Court rejected the argument that the taxpayer attacking the West Virginia tax scheme described above was required to show that other states where it did business actually applied a manufacturing tax to it that caused its total tax burden to be higher than the tax burdens of its in-state competitors who benefitted from the challenged exemption.[67] The Court held that if this were the test it " would depend on the shifting complexities of the tax codes of 49 other States, and ... the validity of the taxes imposed on each taxpayer would depend on the particular other States in which it operated." [68]
To show injury here Tesoro is not required to demonstrate that multiple taxation has resulted because other states have treated it unfairly. It must only show that there is a risk of multiple taxation because this state, Alaska, has treated it unfairly. But unlike the taxpayer in Armco, Tesoro has not made this showing. In Armco, the taxpayer was an out-of-state manufacturer that suffered injury because West Virginia refused to grant it a tax exemption that was available to in-state manufacturers.[69] West Virginia could have cured the injury by granting the exemption to the taxpayer regardless of the location of the taxpayer's manufacturing activity. By contrast, Tesoro has suffered no injury as a result of DOR's failure to apply the property, sales, and payroll formula to it because application of this formula in Alaska would have caused Tesoro's Alaska tax burden to increase. The risk of double taxation that Tesoro alleges is not affected by Alaska's choice between two possible three-factor tax formulas. Instead, the risk of double taxation in this case is caused entirely by the possibility that California and Texas may choose tax formulas that would increase Tesoro's tax burden. Because Tesoro has not demonstrated that it has suffered any harm as a result of the alleged internal inconsistency, it has failed to establish its standing in this case. We do not see why a taxpayer should be excused from application of a tax scheme whose alleged internal inconsistency results in no-less-favorable tax treatment than would have resulted from a consistent scheme.
B. The Administrative Law Judge Did Not Err In Finding That DOR's Alternative Apportionment Formula Was Reasonable As Applied To Tesoro.
Alaska Statute 43.19.010, article IV, subsection 18(c) gives DOR the authority to add an additional factor to an apportionment formula if the formula otherwise prescribed by statute does not fairly represent the extent of the taxpayer's in-state business activity. But section 18 permits DOR to apply an alternative formula only " if reasonable." [70]
Page 847
As we have stated in the past, " [i]nherent in the use of formula apportionment is the legislative decision that a certain degree of distortion will be tolerated." [71] In determining whether the section 18 remedial formula DOR adopted met the statutory " if reasonable" test, the question is whether the formula is within tolerable limits.[72]
DOR argues that the administrative law judge correctly placed the burden on Tesoro to prove the unreasonableness of DOR's remedy. There is contrary authority that indicates that if a taxing state invokes section 18 of the Multistate Tax Compact to deviate from a prescribed tax statute, it bears the burden of proving the reasonableness of the proposed alternative.[73] We do not need to decide whether DOR had this burden, because even if DOR had the burden of proving the reasonableness of its proposed remedy, it met this burden.
1. The property and sales factors were reasonable as applied to Tesoro.
Courts have traditionally judged the reasonableness of an apportionment formula by applying the constitutional test of external consistency.[74] The external consistency test evaluates whether the tax " reflect[s] a reasonable sense of how [the taxpayer's] income is generated." [75] Although the constitutional cases are not directly relevant to the statutory question of whether a given formula meets the " if reasonable" test of section 18, they provide useful guidance in deciding this issue.
During the contested years, DOR applied the three-factor property, sales, and extraction formula of AS 43.20.144(c)(3) to apportion Tesoro's income. Tesoro argues that the property and sales factors were unreasonable as applied to it, and advances three challenges to DOR's calculation of the property factor.
First, Tesoro argues that because the R & M subsidiaries invested in massive infrastructure in Alaska, while the E & P subsidiaries' out-of-state property holdings consisted of leased land and partially owned equipment, the property factor overvalued Tesoro's in-state activities. Tesoro's argument seems to be that because it owned more property in Alaska than elsewhere, the property factor is distortive. But the property factor uses a taxpayer's in-state property as an estimate of the " protection, benefits, and services that the state furnishes to the enterprise and of the costs that the enterprise imposes upon the state." [76] As DOR observes, Tesoro's ownership of " massive infrastructure" in Alaska shows that it made greater use of state protections and benefits in Alaska than in other areas where its property holdings were more modest. There is nothing distortive about attributing Tesoro's tax burden accordingly.
Page 848
Second, Tesoro argues that DOR's calculation of the property factor unreasonably undervalued its out-of-state assets by calculating their value at cost and not at fair market value. As DOR points out, we have already considered and rejected this argument. In Gulf Oil, we declined to value non-producing wells at their market value instead of at their cost.[77] We noted that if we valued one asset in the property factor calculation at market value, we would have to so value all assets.[78] We refused then to assign DOR this " formidable task." [79] Other courts considering this issue have reached the same result.[80] Gulf Oil forecloses Tesoro's argument.
Third, Tesoro argues that the property factor was distortive because it excluded intangible property and thus excluded a valuable contract that an E & P subsidiary owned during the relevant period. Excluding intangible property in the calculation of the property factor is a practice that has been universally accepted across states.[81] Most courts have adhered to this general rule even if, as here, the taxpayer asserts that the exclusion of a particularly valuable intangible asset causes unreasonable distortion of the property factor.[82] We are unpersuaded by Tesoro's argument that DOR's adherence to this widely accepted practice was unreasonable.
Tesoro also argues that DOR's calculation of the sales factor is unreasonable because it takes into account gross income and not net profits. Tesoro contends that such a calculation overvalues its business activities in state relative to its activities out of state because its in-state businesses were high volume but low margin, while its out-of-state businesses were low volume but high margin. Again, Tesoro quarrels with universally accepted taxing practice. Every state with a broad-based corporate income tax uses a gross sales or gross receipts factor in its apportionment formula.[83] Furthermore, as DOR observes, the United States Supreme Court has rejected the argument that disparate profits across subsidiaries are indicative of unfair taxation.[84]
Regardless, formula apportionment is meant to measure " the corporation's activities within and without the jurisdiction." [85] Tesoro's sales factor argument is built on the flawed premise that a business's in-state activities are only as great as the profits it generates from its in-state activities. In fact, the sales factor is designed to attribute a taxpayer's income to the jurisdictions in which its goods and services are consumed.[86] Tesoro admits that the R & M subsidiaries " sold a large volume of gasoline each day" as compared to E & P's " small-scale operation," which generated " far more modest" sales. But Tesoro contends that we should ignore the relative size of R & M's business operations as compared to E & P's and instead focus on the relative size of the net income generated by these operations. We reject Tesoro's argument because we
Page 849
conclude that a business's in-state activities may be fairly measured by the amount of goods or services that consumers purchase in state regardless of whether the business later turns a profit or loss on those purchases.
In support of its position that profits and not sales should be used to measure in-state business activities, Tesoro cites cases in which other courts have held that taxing states could vary their apportionment formulas to account for the distortion caused by including in the sales factor gross sales generated by a corporate treasury department's short-term investment receipts. [87] This body of case law is distinguishable for two reasons. First, in the cited cases, distortion resulted because the short-term investments served no operational function and were thus qualitatively different from the companies' other business activities.[88] There is no risk of similar distortion here because R & M was an operational segment; its sales therefore could reasonably be compared to those of Tesoro's other major operational segment, E & P. Second, in the cases Tesoro cites no court held that an adjustment was required; the courts held instead that an adjustment was constitutionally permissible. [89] Tesoro cites no authority for its position that because one of Tesoro's operational segments was less profitable than the others the sales factor is unreasonably distortive.
2. The overall formula was reasonable as applied to Tesoro.
Tesoro argues that unreasonable distortion can be seen in the disparity between the income subject to taxation under the section 18 remedial formula and the income that would be subject to taxation under separate accounting. Tesoro asserts that because DOR taxed $89 million in income whereas under separate accounting it would have taxed only $14 million in income, DOR taxed $75 million that was " unquestionably generated" outside Alaska.
Tesoro mistakenly assumes that it is possible to determine where the income of a unitary business is " unquestionably generated." In Container Corp., the United States Supreme Court stated that the " basic theoretical weakness" of separate accounting is that for a unitary business it is " misleading to characterize the income of the business as having a single identifiable ' source.' " [90] Tesoro cites the United States Supreme Court's 1931 decision in Hans Rees' Sons, Inc. v. North Carolina [91] for the proposition that a state's apportionment should be struck down if the taxpayer is able to show a large disparity between the income taxed under separate accounting and the income taxed under the state's apportionment formula. But the Hans Rees' Sons Court never explicitly held this, and in the years since it decided that case the United States Supreme Court has declined to hold formula apportionment unreasonable even when presented with a large disparity between the income that would have been taxed under separate accounting and the income that was actually taxed under formula apportionment.[92] We also reject the
Page 850
argument that such a disparity, without more, renders an apportionment unreasonable.
C. The Administrative Law Judge Did Not Err In Finding Penalties To Be Permissible In This Case.
DOR's September 21, 2001 assessment imposed failure-to-pay and negligence penalties against Tesoro. Relying on the 1999 Attorney General's Opinion that AS 43.20.144's tax scheme was unconstitutional, Tesoro argues that as a matter of law it cannot be penalized for failing to pay taxes under an unconstitutional apportionment scheme. We are unpersuaded for two reasons. First, as the United States Supreme Court has held, a state may require, under threat of penalty, that a taxpayer pay a tax before contesting it.[93] Second, DOR did not assess the penalties because Tesoro failed to acquiesce in AS 43.20.144's apportionment scheme, but because Tesoro failed to acknowledge that KPL was unitary with R & M.
Tesoro repeatedly took the position that its Alaskan refinery was not unitary with the Alaskan pipeline that fed it, despite the obvious invalidity of this position [94] and despite DOR's October 1, 1998 determination that KPL and R & M were unitary. DOR there found that " Tesoro is one unitary petroleum business" and that " the entire group is subject to modified apportionment under AS 43.20.072." Notwithstanding that 1998 finding, Tesoro not only failed to amend its filings for the years 1994-1997 to reflect its unitary business, but it also thereafter filed its 1998 tax return as if KPL were a wholly separate enterprise. DOR's September 18, 2001 assessment imposed penalties against Tesoro for failing to amend its 1995-1997 filings and for again asserting the same, invalid position in its 1998 return. It was not until June 2005— almost four years after the penalties were assessed and more than six years after the 1998 determination— that Tesoro amended its filings to reflect DOR's 1998 unitary finding. Tesoro's unjustified position would have warranted penalties regardless of what apportionment scheme was ultimately applied to it. DOR permissibly assessed the penalties.
For these reasons, we AFFIRM the superior court's decision that affirmed the administrative law judge's award of taxes, interest, and penalties.
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April 15, 1935
MANHATTAN GENERAL EQUIPMENT CO.v.COMMISSIONER OF INTERNAL REVENUE; COLLIER SERVICE CORPORATION V. SAME
Appeal from the Board of Tax Appeals.
Before MANTON, AUGUSTUS N. HAND, and CHASE, Circuit Judges.
AUGUSTUS N. HAND, Circuit Judge.
The first question before us is whether there was any deductible loss in 1925 because of the cancellation of the contract between Artemas Ward and Interborough Rapid Transit on November 1, 1925. This depends on whether the deductions for exhaustion allowed to Artemas Ward between March 1, 1913, and March 13, 1922, when the latter transferred the contract to Artemas Ward, Inc. (N.Y.), in exchange for all the stock of that corporation, should be added to the deductions for exhaustion allowed to Artemas Ward, Inc. (N.Y.), between the date of transfer and the time of cancellation. If the allowances granted to Artemas Ward and to his transferee Artemas Ward, Inc. (N.Y.), may all be taken into account, no part of the March 1, 1913, value of the contract would remain, so that there would be no deductible loss due to the cancellation on November 1, 1925.
The contract transferred by Artemas Ward to Artemas Ward, Inc. (N.Y.), was acquired by the latter pursuant to such a nontaxable exchange as is described in section 203 (b) (4) of the Revenue Act of 1926, 26 USCA § 934 (b) (4), which provides that: "(4) No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock * * * in such corporation, and immediately after the exchange such person or persons are in control of the corporation. * * *"
Section 204 (a) (8) of the same act, 26 USCA § 935 (a) (8), provides that:
"The basis for determining the gain or loss from the sale or other disposition of property acquired after February 28, 1913, shall be the cost of such property; except that -- * * *
"(8) If the property * * * was acquired after December 31, 1920, by a corporation by the issuance of its stock * * * in connection with a transaction described in paragraph (4) of subdivision (b) of section 203 [section 934], * * * then the basis shall be the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor upon such transfer under the law applicable to the year in which the transfer was made."
In spite of the fact that the transfer of the contract from Artemas Ward to Artemas Ward, Inc. (N.Y.), was under section 203 (c) (4), supra, a nontaxable exchange and the basis for determining the disposition of the contract was under section 204 (a) (8), the same as it would be in the hand of the transferor, the petitioners argue that the basis should only be diminished by the amount of the deductions for exhaustion which were allowable after Artemas Ward, Inc. (N.Y.), acquired the contract. This argument is founded on section 202 (b) (2) of the Revenue Act of 1926, 26 USCA § 933 (b) (2), which says that in computing the amount of gain or loss from the disposition of property: "(2) The basis shall be diminished by the amount of the deductions for exhaustion, wear and tear, obsolescence, amortization, and depletion which have since the acquisition of the property been allowable in respect of such property under this Act [title] or prior income tax laws."
The petitioners contend that the word "acquisition" means acquisition to the taxpayer. But where there has been a nontaxable exchange we think the "acquisition" referred to is that of the transferor. It is impossible to see why different rules should be employed for determining profit or loss where items of exhaustion are or are not allowable and where property that has been the subject of a nontaxable exchange is sold or otherwise disposed of. The purpose of the statutory provisions we have quoted was to disregard the corporate intervention when computing gain or loss in such cases. Under section 204 (a) (8) the basis is "the same as it would be in the hands of the transferor, increased in the amount of gain or decreased in the amount of loss recognized to the transferor." To allow deductions for exhaustion under a different principle or in a more limited way would contravene the entire theory applicable to nontaxable exchanges. Perthur Holding Corp. v. Commissioner, 61 F.2d 785 (C.C.A. 2); Bender (C.C.A.) 70 F.2d 655. The Board of Tax Appeals properly took into account items allowed for exhaustion when the contract was in the hands of the transferor and rightly disallowed any loss through cancellation because the value had already been exhausted.
It is now necessary to deal with the second point raised by the taxpayer. That is whether the loss on the sale of the 4,964 shares of Artemas Ward, Inc. (N.Y.), which the United Brokerage Company and its affiliates were entitled to, was $2,167,785.56 as claimed, or was only $495,696.76, the loss allowed by the Board. This depends on what portion of the amount paid for the stock by United Brokerage Company is allocable to the stock of Artemas Ward, Inc. (N.Y.), and what portion to the stock of Artemas Ward, Inc. (Del.). This in turn depends on whether Article 1599 (2) of Regulations 69 should be applied in its original form or as it stood after amendment in 1929.
Section 203 (c) of the Revenue Act of 1926, 26 USCA § 934 (c), provided that, if there is distributed, to a shareholder in a corporation, a party to a reorganization, stock in such corporation or in another corporation, a party to the reorganization, without the surrender by the shareholder of the stock originally held, no gain to the stockholder shall be recognized. Section 204 (a) (9) of the act, 26 USCA § 935 (a) (9), provided that where (as here) such distribution was made after December 31, 1923, "the basis in the case of the stock in respect of which the distribution was made shall be apportioned, under rules and regulations prescribed by the Commissioner with the approval of the Secretary, between such stock and the stock or securities distributed."
The question is whether Article 1599 (2), supra, applied to its earlier form or as later amended on November 13, 1929. Before the amendment, Article 1599 (2) read thus: "Where the stock distributed in reorganization is in whole or in part of a character or preference materially different from the stock in respect of which the distribution is made, the cost or other basis of the old shares of stock shall be divided between such old stock and the new stock in proportion, as nearly as may be, to the respective values of each class of stock, old and new, at the time the new shares of stock are distributed, and the basis of each share of stock will be the quotient of the cost or other basis of the class with which such share belongs, divided by the number of shares in the class. The portion of the cost or other basis of the old shares of stock to be attributed to the shares of new stock shall in no case exceed the fair market value of such shares as of the time of their distribution."
Where the new stock is stock of a corporation different from the old, it has been treated as stock of "a character or preference materially different" within the meaning of the foregoing regulations. Accordingly, if Article 1599 (2) as it read at the time of the sale of the 4,964 shares of Artemas Ward, Inc. (N.Y.), be applied, the last sentence of (2) would entitle the United Brokerage Company to a loss of $2,167,785.56. This is because the portion of the cost of the old stock to be attributed to the new stock could not exceed the fair market value of the 100 shares of stock of Artemas Ward, Inc. (Del.), at the time of the distribution of the latter. As we have shown in the statement of facts, the value of the latter stock at that time was $961,952.86. If $961,952.86 be deducted from $3,414,345.63 (the cost of the shares of Artemas Ward, Inc. [N.Y.], to United Brokerage Company), there would remain $2,452,392.77 as the base or proportion of the cost of the old stock applicable thereto after the reorganization. If from $2,452,392.77 be deducted $234,967.21 of accounts receivable distributed by Artemas Ward, Inc. (N.Y.), to United Brokerage Company, and $49,640 realized by the United Brokerage Company from the sale of the 4,964 shares of stock of Artemas Ward, Inc. (N.Y.), we have a balance amounting to $2,167,785.56 -- the loss claimed by the taxpayer.
Limitation by the last sentence of subdivision (2), supra, to the fair value of stock of Artemas Ward, Inc. (Del.), at the time of distribution would make the proportion of cost to United Brokerage Company represented by that stock only about 28 per cent., though the Delaware Company had received 77.15 per cent. of the assets of the old company. Doubtless, because such a limitation was thought to attribute in situations like the present too small a proportion of the basis cost to the stock of the new corporation distributed to stockholders through a reorganization, the Commissioner amended Article 1599 (2) on November 13, 1929, by omitting the last sentence of subdivision (2). Applying the regulation as amended, he computed the loss on the sale of the stock of Artemas Ward, Inc. (N.Y.), at $495,696.76. The Board by employing that loss in determining the income of the affiliated corporations arrived at the income tax deficiencies under review. We cannot see that the method of apportionment required by the amendment was unreasonable, and if the Commissioner had the right to apply the Regulation, as amended in 1929, to prior transactions under which the taxpayers would be entitled to deduct a larger loss, the decisions of the Board were right.
The taxpayers argue that the Commissioner had no right to apply the Regulations, as amended, to prior transactions, and cite Arizona Grocery Co. v. Atchison, T. & S.F.R. Co., 284 U.S. 370, 52 S. Ct. 183, 76 L. Ed. 348, in support of their contention. But Great Northern R. Co. v. Sunburst Oil & Refining Co., 287 U.S. 358, 53 S. Ct. 145, 77 L. Ed. 360, 85 A.L.R. 254, indicates that the former decision does not govern the present situation. The latter decision shows that if under power to adopt Regulations delegated by Congress to the Commissioner authority is given to change the Regulations, the Regulations are to the extent of that power tentative as to any matters affected, and that the changed Regulations, if reasonable, may be applied retroactively. In Great Northern R. Co. v. Sunburst Oil & Refining Co., 287 U.S. 358, 53 S. Ct. 145, 77 L. Ed. 360, 85 A.L.R. 254, this principle was applied in the case of freight rates which had been charged under a power to fix and to change the same delegated by the state of Montana to its Board of Railroad Commissioners. The rates wre afterwards lowered by the State Board and the shipper was allowed to recover the excess from the carrier. In Titsworth v. Commissioner, 73 F.2d 385 (C.C.A. 3), the very argument presented here of the inability of the Commissioner to apply amended Article 1599 (2) retroactively was made without avail. Cf. Burnet v. S. & L. Bldg. Corp., 288 U.S. 406, 53 S. Ct. 428, 77 L. Ed. 861.
There can be no doubt that Congress has power to make income tax laws retroactive. Brushaber v. Union Pac. R. Co., 240 U.S. 1, 11, 36 S. Ct. 236, 60 L. Ed. 493. This is especially true where they only affect deductions that may be taken from income, which are always matters of legislative favor. Under the Revenue Act of 1924 and 1926 the Commissioner was given discretion to apply his regulations without retroactive effect if the reversal of a former ruling was not immediately occasioned by a decision of a court of competent jurisdiction. Revenue Act 1924, § 1008 (a), and Revenue Act 1926 § 1108 (a), 26 USCA § 1251 note. Under the Revenue Act of 1928, § 605 (26 USCA § 1251 (a), the Commissioner was given the same discretion without the limitation as to how the change in his former ruling was occasioned. Under the Revenue Act of 1934, § 506 (26 USCA § 1251 (a), the 1928 provision was practically reiterated. Each of these enactments shows that the Regulations of the Commissioner are to be regarded as tentative for the reason that amendments are retroactive unless stated to be otherwise. Accordingly the Regulations in question are to be treated as retroactive to the date of the law to which they are applicable.
Orders affirmed.
MANTON, Circuit Judge, dissenting in a separate opinion.
MANTON, Circuit Judge (dissenting).
This appeal involves income taxes for 1925 and 1926, of both petitioners. The questions presented are: (1) Where a corporation which acquired a contract in a nontaxable exchange for stock pursuant to a transaction described in section 203 (b) (4) of the Revenue Act of 1926, 26 USCA § 934 (b) (4), and hence under section 204 (a) (8) of the act, 26 USCA § 935 (a) (8), is required to use the basis of the transferor in measuring the loss from the cancellation of that contract, should that basis be reduced by the amount of deductions for exhaustion allowable to the corporation taxpayer only or by the total exhaustion allowable to both the taxpayer and the transferor; and (2) whether the loss sustained in 1926 on the sale of stock, received in a nontaxable distribution in pursuance of a plan of reorganization, should be determined upon the basis of regulations in effect in 1926 (article 2599, Regulations 69), or upon the basis of an amended regulation promulgated in 1929 (article 1599, Regulations 69).
Artemus Ward, prior to March 1, 1913, had a contract for advertising, vending, and news selling privileges on the cars and stations of the subways and elevated railways of the Interborough Rapid Transit Company. The fair value of this contract was appraised by the Commissioner, as of March 1, 1913, at $3,028,096.42. March 13, 1922, Artemus Ward transferred this contract to a New York corporation, Artemus Ward, Inc., in exchange for the stock of the corporation. The United Brokerage Company which filed a consolidated return with the petitioners, purchased the entire issued and outstanding capital stock of Artemus Ward, Inc., consisting of 4,964 shares of no par value, on June 30, 1925, for $3,414,345.63. This contract was canceled November 1, 1925. In the consolidated return filed by the United Brokerage Company for 1925, the income and deductions of Artemus Ward, Inc., were included for the period of July 1 to December 31, 1925. One deduction claimed by Artemus Ward, Inc., was a loss resulting from the cancellation of the contract, and it was disallowed by the respondent. In the petition filed with the Board, petitioner claimed a deduction for the loss sustained, in the sum of $605,619.30. This was computed by reducing the March 1, 1913, valuation of $3,028,096.42 by annual deductions for the exhaustion of the life of the contract on the basis of a remaining life on March 1, 1913, of 15 5/6 years. The exhaustion so computed amounted to $2,422,477.12, leaving an unexhausted March 1, 1913, value of $605,619.30. The respondent computed the amount of exhaustion allowable both to the transferor Artemus Ward, the individual, and to the transferee, Artemus Ward, Inc., in terms of March 1, 1913, value, at the rate of $191,248.20 per year, except in 1922 and 1923, when an allowance was permitted for exhaustion of the contract in the amount of $766,642.59 for each of the two years. The deductions allowable for exhaustion of the contract during the period it was owned by Artemus Ward, Inc., were $613,314.07 for 1922, and $766,642.59 for 1923, based upon the value at the date of the acquisition of the contract by Artemus Ward, Inc., on March 13, 1922.
The plan of reorganization referred to in the prevailing opinion became effective during 1925, and in 1926, the United Brokerage Company sold the shares of Artemus Ward, Inc. (N.Y.), for $49,640.
In its return for 1926, the United Brokerage Company claimed a deduction of $3,062,314.54 as a loss resulting from the sale of the stock of Artemus Ward, Inc. (N.Y.). This loss was computed in accordance with the provisions of subdivision (1) of Article 1599, Regulations 69, then in the effect for sales made in 1926. But the respondent applied the provisions of Article 1599 (2) of Regulations 69, as amended November 13, 1929, and determined the loss sustained to be $495,696.76. The distribution to the United Brokerage Company on December 31, 1925, of the stock of Artemus Ward, Inc. (Del.), worth $961,952.86, and accounts receivable worth $234,967.21 was followed, in December 1926, by the sale of the stock of Artemus Ward, Inc. (N.Y.), for $49,640, and this made it possible to ascertain the amount of the loss which had been sustained by the parent company. It paid $3,414,345.63 for the stock of the New York corporation, and it received assets worth only $1,246,560.07, and therefore suffered a loss of $2,167,785.56 on the transaction.
Pursuant to section 204 (a) (8), this basis for determining the gain or loss from the sale of the contract in the hands of Artemus Ward, Inc., was the same as it would be in the hands of Artemus Ward, the transferor, $3,018,086.42. The reason the loss sustained by cancellation of the contract was disallowed was that the aggregate amount of the deductions allowed or allowable for the exhaustion of the contract to Artemus Ward, the transferor, from March 1, 1913, to March 13, 1922, and to Artemus Ward, Inc., subsequent to the time said contract was acquired by it on March 13, 1933, and prior to November 1, 1925, was in excess of the basis of $3,028,096.42. Under the provisions of section 202 (b) (2) of the Revenue Act of 1926, 26 USCA § 933 (b) (2), the basis to Artemus Ward, Inc., of $3,028,096.42 is reduced only by the aggregate of deductions allowable to it for exhaustion of such contract during the period the contract was owned by it. The aggregate amount of the deductions allowable to it for the exhaustion was $7,730,578.36; thus Artemus Ward, Inc., suffered a loss of $1,297,518.06. The value of this contract to the transferee, Artemus Ward, Inc., must be computed undiminished by any exhaustion allowed or allowable to the transferor, Artemus Ward. It should not include any deductions for exhaustion which may have been allowed or allowable to the transferor, Artemus Ward, prior to March 13, 1922.
Section 203 (c) of the Revenue Act of 1926, 26 USCA § 934 (c), provides that if there was distributed to a shareholder in a corporation a party to a reorganization, stock in such corporation or in another corporation a party to the reorganization, without the surrender of the stock originally held, no gain to the shareholder should be recognized. Section 204 (a) (9) of the act, 26 USCA § 935 (a) (9), provides that in such cases the basis of the old stock should be apportioned between the old and new stock under rules and regulations prescribed by the Commissioner. Regulations 69, Art. 1599, promulgated August 28, 1926, provided that where the new stock was of substantially the same character or preference as the old stock, the basis of each share should be determined by dividing the cost of the old stock by the total number of old and new shares. Paragraph 2 provided that where the new stock was of a character or preference materially different from the old stock, the cost of the latter should be divided between the old and the new stock in proportion to the respective values of each class of stock at the time of distribution, but with the proviso that the basis of the old shares of stock to be attributed to the new stock shall in no case exceed the fair market value of such shares as of the time of their distribution. Thus, if the allocation is to be made under paragraph 2 of Article 1599, the cost of the old stock would be divided between he old and the new in proportion to the respective values of each class; the amount to be attributed to the new stock not to exceed the value of such stock under the limitation contained in the article as then promulgated. The value of the new stock was $961,952.86; the remainder of the cost of $3,494,345.63, that is $2,452,392.77, should be allocated to the old stock, and after deducting the accounts receivable and the sum received when the old stock was sold, there was a loss of $2,167,785.56. This is the actual loss sustainted by the United Brokerage Company as shown in the statement of facts.
The prevailing opinion holds that the original article is inapplicable by reason of the promulgation, on November 13, 1929, of an amendment to Article 1599 of Regulations 69, providing explicitly that where the stock distributed was stock in a corporation other than the distributing corporation, the basis of the old stock should be apportioned under paragraph 2 of the article, omitting the last sentence of the original article. The prevailing opinion thus applies the amended article to the distribution made by Artemus Ward, Inc., on December 31, 1925, retroactively. Great Northern R. Co. v. Sunburst Oil & Refining Co., 287 U.S. 358, 53 S. Ct. 145, 77 L. Ed. 360, 85 A.L.R. 254, is relied upon.
In Arizona Grocery Co. v. Atchison, T. & S.F. Ry. Co., 294 U.S. 370, 52 S. Ct.183, 76 L. Ed. 348, the holding of the court was that when the Interstate Commerce Commission declares a certain rate to be a reasonable rate, it speaks as the Legislature and its pronouncement has the force of a statute, the Interstate Commerce Commission, in naming the rate, speaking in a quasi legislative capacity. This being so, the court held that the Interstate Commerce Commission cannot, by a later provision, declare its own finding of reasonableness to be erroneous and subject to a carrier, which conformed thereto, to a reparation measured by what the Interstate Commerce Commission later holds it should previously have decided. The Great Northern Ry. Case, supra, in no way changed this holding. In that case, the court held that where it is clear to all concerned that a rate as fixed is but tentative and provisional, the rate may be changed retroactively. The court found that notice had been given to all that the rate was subject to retroactive change. The court said that the Arizona Case, supra, was not in conflict with such view, because Congress had not there intended that the Interstate Commerce Commission have power to change rates retroactively. The Great Northern Case in no way implied, as might be concluded from the prevailing opinion, that the mere power to change regulations makes such regulations only tentataive, and therefore capable of being applied retroactively when changed. The very "meat" of the Great Northern Case was that all concerned knew and understood that the rates, as fixed, were originally tentative, not that they were simply subject to change. Where regulations are only subject to change, but are not understood to be tentative, the Arizona Case, supra, applies, and they cannot be applied retoractively.
Prior to the enactment of the 1926 Act, the authority of the Commissioner arbitrarily to decide whether or not later regulations were to be applied retroactively was seriously questioned. As a result, the Revenue Act of 1926, § 1108 (a), 26 USCA § 1251 note, gave the Commissioner a wide discretion. The discretion was not to apply it with retroactive effect, but without retroactive effect. The 1928 Act is in the same terms. Section 605, Revenue Act of 1928, 26 USCA § 1251 (a). "The purpose of the above provision of law is to prevent the constant reopening of cases on account of changes in regulations or treasury decisions." Prentice-Hall Tax Service (1934) § 21,207. The 1934 Act, § 506, 26 USCA § 1251 (a), provides that the Secretary or Commissioner, with the former's approval, may prescribe the extent, if any, to which any regulation shall be applied "without retroactive effect." See Report Ways & Means Committee, 1934.*fn*
The retroactivity of an amended regulation may depend upon whether the regulation under discussion declares the law or merely interprets it. If the latter, then the regulation, in reality, has no retroactive effect of itself. The regulation would be only interpretive of the statute which imposes the tax. If, on the other hand, it is declarative of the law, then the amended regulation might well be invalid if it adversely and unjustly affected the taxpayer. The Report of the Ways and Means Committee recognized the distinction and also that those regulations, which are of a nature other than merely interpretive, often work inequitable results when applied retroactively. This fact, which was considered a reason for giving the Commissioner discretion to apply regulations nonretroactively, is also a reason for refusing to give a retroactive effect to an amended regulation even though the Commissioner does not exercise his discretion.
Congress did not declare, in section 204 (a) (9), the method by which the basis should be apportioned. Rather, it delegated to the Commissioner the power to make rules and regulations for such apportionment with the approval of the Secretary. To say that the Commissioner is merely interpreting the law in such case is erroneous. Before the Commissioner promulgated Article 1599 of Regulation 69, there was no law in regard to the method to be used in apportioning the basis, and the Commissioner, when he promulgated the article, made the law. The regulation was not interpretive of the law, because before the regulation there was no law. The Commissioner acted in what the Supreme Court, in the Arizona Grocery Case, supra, called a quasi legislative manner. Regulations made by the Commissioner in pursuance of his delegated authority, with the Secretary's approval, have the force and effect of statutes. U.S. v. Eliason, 16 Pet. 291, 10 L. Ed. 968; In re Huttman (D.C.) 70F. 699. And so, when the Commissioner, in accordance with his delegated power, acts in behalf of Congress is enacting such a regulation as is considered in the instant case, the regulation promulgated by him will be considered declarative of the law, and quasi legislative in nature. Consequently, the regulation should not be applied with retroactive effect. To do so would be unreasonable and capricious. Untermyer v. Anderson, 276 U.S. 440, 48 S. Ct. 353, 72 L. Ed. 645; Nichols v. Coolidge, 274 U.S. 531, 47 S. Ct. 710, 71 L. Ed. 1184, 52 A.L.R. 1081; Arizona Grocery Co. v. Atchison, T. & S.F.R. Co., supra.
The deduction should be allowed, and the decision reversed.
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By Anton Ruin
Undoubtedly, the growth of mobile ad sector within the past 2 years is absolutely impressive. With the total value of mobile traffic having already increased for almost 10 times, mobile advertising opportunities have come into focus in all spheres of the market, including those where mobile ads weren't considered very essential at least 2 – 3 years ago.
Beheading the fresh holiday season, world's experts have already outlined several major mobile ad trends that are likely to rule in 2014, many of which were widely discussed during the latest IAB MIXX Conference in NYC. The majority of foreseen tendencies are rather similar to already governing ones with a few slight differences influenced by audience's changing demands.
Similar to 2013 the most promising segments and categories in mobile advertising of 2014 are forecasted as entertainment and gaming. The latter has gotten to the top of customers' ratings; mostly due to the growing popularity of social games and the recent increase of mobile in-game purchases (e.g. up to 44% of gamers in the US stated they had made in-game purchases in Q2, 2013).
In this respect, the further development of mobile video ad solutions will, undoubtedly, allow marketers to benefit from gaming and entertainment ad campaigns even more next year.
The fast ascent of mobile advertising is currently displayed all over the world and the experts' forecasts for the next year are also exceptionally promising. In this respect, the amount of mobile ad spending in US and Canada is expected to increase up to about $12B in 2014, and South American regions are likely to spend much more on mobile ad campaigns as well (approximately $279,8M).
As for Central and Eastern European countries, the Russian Federation remains on top in its mobile advertising. The total amount of mobile ad spending in this part of the world is expected to grow for another 2, 5% in 2014 and reach the estimated $273,2M.
Ad Formats
As mentioned above, mobile video ads are foreseen to become the top-1 ad format in 2014 along with the complex ad campaigns that constitute a wide range of rich media & video ad content. The latter have become widely-applied in advertising campaigns this year, including ads for the holiday season as well and will apparently remain equally or even more popular next year.
The most engaging mobile rich media format is considered to be IAB Rising Stars, which has already proven to show the average 98, 4% audience responsiveness. Naturally, these are expected to be widely-used by companies, interested in maximizing the effectiveness of their mobile ad campaigns.
Devices & OS's
Similar to 2013 trends iOS mobile devices (iPhones & iPads) will remain at the top regarding monetization possibilities in 2014, especially given the recent introduction of brand-new iPhone 5S and iPhone 5C models.
As for Android mobile devices, the surveys show the increase of their market share up to 31% of the global market; which is why mobile ad campaigns on Android smartphones and tablets are also potentially advantageous to launch.
Tablets will remain hotter for mobile marketers, much due to the larger device size, in the first place. Additionally, these happen to provide better user experience, since the page content (images and video) is loaded relatively faster.
About the author
Anton Ruin is Epom's CEO.