Appeal of A.M. Castle & Co.

Decision Date08 December 1989
Docket NumberNo. 62954,62954
Citation783 P.2d 1286,245 Kan. 739
PartiesIn The Matter of the Appeal of A.M. CASTLE & CO. from a Notice of Assessment of Additional Corporate Income Tax.
CourtKansas Supreme Court

Syllabus by the Court

1. K.S.A.1988 Supp. 74-2426(c) provides that orders of the BOTA are subject to judicial review in accordance with the Act for Judicial Review and Civil Enforcement of Agency Actions, K.S.A.77-601 et seq.

2. A multi-state business is a unitary business for income tax purposes when the operations conducted in one state benefit and are benefited by the operations conducted in another state or states. If its various parts are interdependent and of mutual benefit so as to form one integral business rather than several business entities, it is unitary.

3. Whether a multi-state business is separate or unitary depends upon the manner in which its business is conducted. The essential test to be applied is whether or not the operation of the portion of the business within the state is dependent upon or contributory to the operation of the business outside the state. If there is such relationship, the business is unitary.

4. Kansas has adopted the dependency/contribution test as the appropriate test to be applied in determining whether two or more business entities are unitary for taxation purposes.

5. In an appeal by the Kansas Department of Revenue from an order of the Kansas Board of Tax Appeals, the record is examined and it is held: The determination by the Board of Tax Appeals, that A.M. Castle & Co. and its wholly-owned subsidiary, Hy-Alloy Steels Company do not constitute a unitary business operation for purposes of Kansas income taxation, is not supported by substantial evidence, and the order is reversed.

David Prager, III, Kansas Dept. of Revenue, Topeka, argued the cause and was on the brief, for appellant.

S. Lucky DeFries, of Schroeder, Heeney, Groff & Coffman, a Professional Association, Topeka, argued the cause and was on the brief, for appellee.

John K. Van de Kamp, Atty. Gen., San Francisco, Cal., of the State of Cal., Robert F. Tyler, Supervising Deputy Atty. Gen., Robert D. Milam, Deputy Atty. Gen., and Benjamin F. Miller, Sacramento, Cal., counsel for multistate tax affairs, were on the amicus curiae brief, for the California Franchise Tax Bd.

Gene Corrigan, Executive Counsel, Boulder, Colo., was on the amicus curiae brief, for the Multistate Tax Com'n.

David L. Skidgel, of McAnany, Van Cleave & Phillips, P.A., Kansas City, F. Leo Faust and Albert D. Kramer, Bartlesville, Okl., and Herbert L. Awe and William L. Goldman, of Lee, Toomey & Kent, of Washington, D.C., were on the amicus curiae briefs, for Phillips Petroleum Co.

HOLMES, Judge:

This is an appeal by the Kansas Department of Revenue (the Department) from an order of the Kansas Board of Tax Appeals (the BOTA) which denied an additional assessment of income tax asserted by the Department against A.M. Castle & Co. (Castle) for the years 1977 through 1979. The denial of the assessment was based upon a determination by the BOTA that Castle and its wholly-owned subsidiary, Hy-Alloy Steels Company (Hy-Alloy), were not conducting a unitary business during the tax period.

In 1982, the Department determined that Castle and Hy-Alloy were conducting a unitary business during calendar years 1977 through 1979. The Department prepared a combined report for Castle and Hy-Alloy, pursuant to K.S.A. 79-32,141, and assessed additional corporate income taxes against Castle in the amount of $24,698. After discovery and a formal hearing, the Director of Taxation upheld the assessment. Castle appealed to the BOTA and, on August 10, 1988, the BOTA reversed the Director's finding that Castle and Hy-Alloy were unitary and ordered the assessment of additional income taxes abated. The Department appealed the decision of the BOTA to the Kansas Court of Appeals (K.S.A.1988 Supp. 74-2426[c], and the case was transferred to the Supreme Court pursuant to K.S.A. 20-3018(c).

The Department asserts several arguments in support of its appeal, but both parties apparently concede that the controlling issue is whether the BOTA was correct in its determination that Castle and Hy-Alloy were not conducting a unitary business. Before turning to a determination of that issue, some preliminary observations would appear to be warranted.

At the outset, the briefs reflect some confusion as to the scope of review of an appeal from the BOTA. K.S.A.1988 Supp. 74-2426(c) specifically provides that orders of the BOTA are subject to judicial review in accordance with the Act for Judicial Review and Civil Enforcement of Agency Actions, K.S.A. 77-601 et seq. Under that act our scope of review is controlled by K.S.A. 77-621, which is somewhat broader than the traditional three-pronged scope of review as set forth in Kansas State Board of Healing Arts v. Foote, 200 Kan. 447, Syl. p 1, 436 P.2d 828 (1968).

In its order the BOTA appears to confuse the term "consolidated return" with the term "combined report," and apparently has used the terms interchangeably. This case involves a determination by the Department that Castle must submit a combined report. In Pioneer Container Corp. v. Beshears, 235 Kan. 745, 684 P.2d 396 (1984), the court discussed the distinction between the two terms, pointing out that the consolidated return, as provided by K.S.A. 79-32, 142, is a method whereby two or more corporations are treated as a single taxpayer and are required to file a consolidated tax return. The court then explained a combined report, stating:

"A combined report is not the same as a consolidated return and does not in any way result in the taxing of one corporation on or measured by the income of another. Actually, the combined report is not a tax return, but, rather, is in the nature of an information return. Notwithstanding its use, each corporation doing business in the taxing state is taxed on or measured by only its own income from sources within the state. However, if the corporation doing business in the state is a member of an affiliated group conducting a business within and without the state, then instead of computing the income attributable to the state on the basis of the corporation's books of account (which may reflect the operation of only a small segment of the business), the apportionment is made with reference to the income from the entire business just as would be done if the business had been conducted by one entity." 235 Kan. 753, 684 P.2d 396.

In Pioneer we held:

"The Director of Revenue is authorized by K.S.A. 79-32,141 to require the combined report method of allocation of income and expenses when it is determined that two or more corporations are engaged in a multi-state unitary business." 235 Kan. 745, 684 P.2d 396, Syl. p 6.

The present case involves the filing of a combined report by Castle based upon the Department's contention that Castle and Hy-Alloy are engaged in a unitary business and does not involve the filing of a consolidated return by the two corporations.

The final preliminary matter to be considered is the proper basis or test to be applied in determining whether two or more entities are engaged in a unitary business. Two tests have been generally used in making such a determination. One is denominated as the three unities test and is based upon three factors, consisting of unity of ownership, unity of operations, and unity of use. This test was used by the California Court of Appeals in what is recognized as one of the leading opinions utilizing the three unities test. Container Corp. of America v. Franchise Tax Bd., 117 Cal.App.3d 988, 173 Cal.Rptr. 121 (1981), aff'd 463 U.S. 159, 103 S.Ct. 2933, 77 L.Ed.2d 545, reh. denied 464 U.S. 909, 104 S.Ct. 265, 78 L.Ed.2d 248 (1983).

The second widely accepted test is the dependency/contribution test, which has been adopted in Kansas. In Crawford Manufacturing Co. v. State Comm. of Revenue and Taxation, 180 Kan. 352, 304 P.2d 504 (1956), the issue was whether Crawford, which conducted a multi-state manufacturing and selling business, constituted a unitary business for purposes of Kansas income tax. The court defined a unitary business and adopted the test to be applied in determining a unitary business as follows:

"A multi-state business is a unitary business for income tax purposes when the operations conducted in one state benefit and are benefited by the operations conducted in another state or states. If its various parts are interdependent and of mutual benefit so as to form one integral business rather than several business entities, it is unitary." Syl. p 1.

"Whether a multi-state business is separate or unitary depends upon the manner in which its business is conducted. The essential test to be applied is whether or not the operation of the portion of the business within the state is dependent upon or contributory to the operation of the business outside the state. If there is such relationship, the business is unitary." Syl. p 2.

In Pioneer the issue was whether Pioneer and its wholly-owned subsidiary, Pioneer Bag Company, constituted a unitary business requiring a combined report. The definition and test adopted in Crawford were also adopted and followed in Pioneer. 235 Kan. [245 Kan. 743] 745, 684 P.2d 396, Syl. pp 3 and 4. Thus, it is clear that Kansas has adopted the dependency/contribution test as the appropriate test to be applied in determining whether two or more business entities are unitary for taxation purposes.

In the present case, the BOTA apparently used the three unities test, stating that the Supreme Court recognized the test in Pioneer. That statement is incorrect. In Pioneer this court quoted from the BOTA order in that case. The BOTA order in Pioneer discussed Container Corporation and pointed out that the test used in that case was the three unities test, and then BOTA used that test in its determination that Pioneer was conducting a...

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