1997 -NMSC- 5, Conoco, Inc. v. Taxation and Revenue Dept. of State of N.M.

• Decision Date: 26 November 1996
• Docket Number: Nos. 22995,23045,s. 22995
• Citation: 122 N.M. 736,1997 NMSC 5,931 P.2d 730
• Parties: , 1997 -NMSC- 5 CONOCO, INC., and Intel Corporation, Plaintiffs-Petitioners, v. TAXATION AND REVENUE DEPARTMENT OF the STATE OF NEW MEXICO, Defendant-Respondent.
• Court: New Mexico Supreme Court

Page 730

931 P.2d 730

122 N.M. 736, 1997 -NMSC- 5

CONOCO, INC., and Intel Corporation, Plaintiffs-Petitioners, v. TAXATION AND REVENUE DEPARTMENT OF the STATE OF NEW MEXICO Defendant-Respondent.

Nos. 22995, 23045.

Supreme Court of New Mexico.

Nov. 26, 1996.

Rehearing Denied Jan. 23, 1997.

Modrall, Sperling, Roehl, Harris & Sisk, P.A., Curtis W. Schwartz, Timothy C. Holm, Santa Fe, Morrison & Foerster, Paul H. Frankel, Walter Hellerstein, Hollis L. Hyans, Irwin M. Slomka, New York City, for Petitioners.

Tom Udall, Attorney General, Bruce J. Fort, Special Assistant Attorney General, Santa Fe, for Respondent.

Mack Easley, Albuquerque, for Amicus Curiae Committee on State Taxation.

Taichert, Wiggins, Virtue & Najjar, Daniel A. Najjar, Santa Fe, for Amicus Curiae Intel Corporation.

OPINION

RANSOM, Justice.

¶1 We here review the constitutionality of New Mexico's formulaic tax scheme for dividends received by a parent corporation from its foreign subsidiaries notwithstanding that dividends received from domestic subsidiaries are excluded entirely from the parent's tax base. This opinion has been amended pursuant to order entered January 23, 1997, in response to motions for clarification and reconsideration. Conoco, Inc., and Intel Corporation had sought the refund of taxes paid by them as separate corporate entities for 1988, 1989, and 1990 over and above their tax liabilities if dividends received from foreign subsidiaries had been deducted from their respective tax bases. Hearing officers for the New Mexico Taxation and Revenue Department denied the refunds. In the Conoco case the hearing officer also upheld an assessment issued by the Department against Conoco for underpaid taxes for 1991. Conoco and Intel each appealed to the Court of Appeals.

¶2 The Court of Appeals decided Conoco's case first and held that the applicable New Mexico corporate income tax scheme does not treat dividends received from foreign subsidiaries less favorably than those received from domestic subsidiaries and therefore is not violative of the Foreign Commerce Clause of the United States Constitution, Article I, Section 8, Clause 3. Conoco, Inc. v. Taxation & Revenue Dep't, 122 N.M. 745, 931 P.2d 739 (Ct.App.1995). We granted certiorari, 120 N.M. 68, 898 P.2d 120 (1995), and allowed Intel to file an amicus curiae brief. The Court of Appeals then held in an unpublished memorandum opinion that the Intel appeal was governed by its decision in Conoco. We granted certiorari for consolidation with Conoco. We find that the applicable New Mexico corporate income tax scheme is unconstitutional, and we reverse the Court of Appeals.

¶3 The Taxpayers. Conoco and Intel both conduct business in New Mexico. Conoco's primary business in New Mexico is exploration, production, and distribution of oil and gas products. Conoco is a wholly owned subsidiary of E.I. Du Pont de Nemours and Company. Intel's primary business in New Mexico is the manufacture of microcomputer components. Both corporations conduct business worldwide through numerous domestic and foreign subsidiaries. None of the foreign subsidiaries conduct business in New Mexico. During all relevant years, both Conoco and Intel filed New Mexico corporate income tax returns as "separate corporate entities."

¶4 New Mexico tax scheme. In Conoco, reported immediately following our instant opinion, Chief Judge Apodaca of the Court of Appeals provides a discussion of the New Mexico corporate income tax scheme. Aside from the Foreign Commerce Clause, on which this case turns, there are other constraints on a state's power to tax multijurisdictional business entities. The Due Process Clause of the Fourteenth Amendment requires "some definite link, some minimum connection, between a state and the person, property or transaction it seeks to tax." Miller Bros. v. Maryland, 347 U.S. 340, 344-45, 74 S.Ct. 535, 539, 98 L.Ed. 744 (1954). A state tax on business activities occurring outside the state satisfies the due process clause only if "the taxing power exerted by the state bears fiscal relation to protection, opportunities and benefits given by the state. The simple but controlling question is whether the state has given anything for which it can ask return." Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444, 61 S.Ct. 246, 249, 85 L.Ed. 267 (1940), quoted in ASARCO Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 315, 102 S.Ct. 3103, 3108, 73 L.Ed.2d 787 (1982). To ensure that the state does not tax value attributable to business conducted outside of the state, a state must use some type of apportionment formula to determine what income was earned within the state and also what portion of income earned extraterritorially is attributable to the corporation's in-state business activity. See Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 439-40, 100 S.Ct. 1223, 1232-33, 63 L.Ed.2d 510 (1980).

¶5 To a corporate taxpayer's base income New Mexico applies an apportionment formula pursuant to the Uniform Division of Income for Tax Purposes Act, NMSA 1978, §§ 7-4-1 to -21 (Repl.Pamp.1995) ("UDITPA"). UDITPA uses a three-part formula to apportion income between that which is subject to New Mexico taxation and that which is not. This apportionment method divides a corporation's assets into a property factor, a payroll factor, and a sales factor. See NMSA 1978, § 7-4-10 (Repl.Pamp.1995). To determine each of the factors, the in-state value of an asset is divided by the total value of the asset (including in-state and out-of-state value). The resulting three fractions are then added together and divided by three to create a multiplier that is applied to the corporation's total income. This calculation yields the apportioned income that is subject to taxation in New Mexico. Id. As discussed later under the "Detroit formula" heading, the Department has attempted to similarly apportion foreign subsidiary dividends to satisfy Foreign Commerce Clause considerations. Whether the Detroit formula satisfies the Foreign Commerce Clause is the determinative issue of this case.

¶6 --Separate corporate entity. During the years relevant to this case, corporations filing tax returns in New Mexico could choose from four different income reporting methods: separate accounting, separate corporate entity, combination of unitary corporations, or federal consolidated group. See Regulations Pertaining to the Corporate Income and Franchise Tax Act, N.M. Tax. and Rev. Dep't, Rule CIT 9:2(B) (1992) (Reporting Methods). Both Conoco and Intel elected to file according to the separate corporate entity method, in which the corporation reports its entire income, to which an apportionment formula is then applied. Under this method a corporation reports income separate from the rest of a unitary group or a group defined by the federal consolidated method. The income of subsidiary corporations is not reported or considered for apportionment. Id. at 2:10 (Separate Corporate Entity).

¶7 Like at least thirty-nine other states, New Mexico uses a corporate taxpayer's federal taxable income, with the deductions allowed by 26 U.S.C. § 243 (1988), as the "base income" for state income tax purposes. See NMSA 1978, § 7-2A-2(C) (Repl.Pamp.1995). Since the entire earnings of domestic subsidiaries are already subject to federal taxation, section 243 of the Internal Revenue Code avoids multiple taxation by allowing corporations to deduct dividends received from domestic subsidiaries. Therefore, dividends from domestic subsidiaries are not included in federal taxable income. To eliminate multiple taxation of earnings of foreign subsidiaries, the federal government allows a subsequent credit to corporations for taxes paid to foreign governments. 26 U.S.C. § 901 (1988). However, dividends from foreign subsidiaries are initially included in federal taxable income. By using federal taxable income as a base, New Mexico excludes domestic but includes foreign dividend income in the state base income. Conoco and Intel contend that including foreign subsidiary dividends in the calculation of New Mexico taxable income while excluding domestic subsidiary dividends facially discriminates against foreign commerce in violation of the Foreign Commerce Clause. See Kraft Gen. Foods v. Iowa Dep't of Revenue, 505 U.S. 71, 112 S.Ct. 2365, 120 L.Ed.2d 59 (1992).

¶8 In Kraft, the U.S. Supreme Court held that Iowa's corporate income tax scheme facially discriminated against foreign commerce in violation of the Foreign Commerce Clause. Iowa, like New Mexico, used federal taxable income as the base income for state income tax purposes, but unlike New Mexico it did not apply the Detroit formula. Iowa made several arguments in support of the proposition that its differential treatment did not constitute prohibited discrimination, but each of these arguments was rejected by the Court. Id. at 74-82, 112 S.Ct. at 2368-72. The Court held that the fact corporations could change their domicile or corporate structure to avoid the disparate effects of the tax did not make the tax constitutional. Id. at 74-78, 112 S.Ct. at 2368-69. The Court also rejected Iowa's argument that because the tax did not favor local commerce it did not violate the Foreign Commerce Clause. "As the absence of local benefit does not eliminate the international implications of the discrimination, it cannot exempt such discrimination from Commerce Clause prohibitions." Id. at 79, 112 S.Ct. at 2370.

¶9 Iowa's claim that its tax scheme was intended to promote administrative convenience rather than economic protectionism was also insufficient to make it valid. Id. at 81-82, 112 S.Ct. at 2371-72. While adopting the federal definition of "taxable income" may bring significant benefits in terms of administrative convenience to both Iowa taxpayers and tax collectors, the Court found these benefits were not the sort of "compelling justification" capable of saving a statute that facially discriminates against...