Caterpillar, Inc. v. C.I.R., C6-97-27

• Decision Date: 11 September 1997
• Docket Number: No. C6-97-27,C6-97-27
• Citation: 568 N.W.2d 695
• Parties: CATERPILLAR, INC., Relator, v. COMMISSIONER OF REVENUE, Respondent.
• Court: Minnesota Supreme Court

Page 695

568 N.W.2d 695

CATERPILLAR, INC., Relator, v. COMMISSIONER OF REVENUE, Respondent.

No. C6-97-27.

Supreme Court of Minnesota.

Sept. 11, 1997.

Syllabus by the Court

Minnesota's water's edge combined reporting method of taxing unitary business groups does not facially discriminate against foreign commerce in violation of the Foreign Commerce Clause.

Sutherland, Asbill & Brennan, L.L.P., Jerome B. Libin, Mary E. Monahan, Washington, DC, Daniel J. Schlicksup, Caterpillar, Inc., Peoria, IL, Faegre & Benson, L.L.P., David R. Brennan, Minneapolis, for Relator.

Hubert H. Humphrey, III, Minnesota Attorney General, Thomas K. Overton, Assistant Attorney General, Tax Litigation Division, St. Paul, for Respondent.

Heard, considered, and decided by the court en banc.

OPINION

PAGE, Justice.

Relator Caterpillar Incorporated ("Caterpillar") raises a constitutional challenge to Minnesota's corporate excise taxation system, alleging that it facially discriminates against foreign commerce in violation of the Foreign Commerce Clause of the United States Constitution. This case arose when Caterpillar sought refunds for Minnesota corporate excise taxes paid on an apportioned share of interest and royalties received from its foreign subsidiaries and a foreign affiliate that were members of Caterpillar's unitary business ¹ during the tax years 1979-81 and 1985-87. Respondent Commissioner of Revenue ("Commissioner") denied Caterpillar's claims for the refunds. On appeal to the Minnesota Tax Court, the tax court upheld the constitutionality of the Minnesota corporate excise taxation system and affirmed the Commissioner's ruling. Caterpillar now appeals the tax court's decision and renews its constitutional challenge. We affirm.

The parties have stipulated to the facts underlying Caterpillar's appeal. Caterpillar and other domestic members of its unitary business licensed their trademarks and technology to foreign members of the unitary business in return for royalty payments. Caterpillar also provided intercompany loans to foreign and domestic members of its unitary business and received interest payments on these loans. During the years in question, three domestic members of the unitary business conducted business activity in Minnesota, which resulted in Caterpillar filing Minnesota corporate excise tax returns. During 1979-87, Caterpillar computed its Minnesota corporate excise tax liability according to Minnesota's "water's edge combined" method of reporting. ² See Minn.Stat. § 290.34, subd. 2 (1986). ³

Because "a State may not tax value earned outside its borders," ASARCO, Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 315, 102 S.Ct. 3103, 3108, 73 L.Ed.2d 787 (1982), the income of a member of a unitary business doing business in Minnesota must be divided between Minnesota and other states. Combined reporting is an accounting device that treats separate corporations engaged in a unitary business as one for the limited purpose of properly accounting for and attributing the income of any one member to a taxing state. Under combined reporting, the income of the members of a unitary business is combined and then apportioned to a particular taxing jurisdiction by using an apportionment formula that takes into account three factors--property, payroll, and sales, see Minn.Stat. § 290.19 (1986)--which represent the three major aspects of business activity within a taxing state. See also Ronald D. Rotunda & John E. Nowak, Treatise on Constitutional Law 192 (2d ed.1992). Fair apportionment ensures that a "State taxes only its fair share of an interstate transaction." Goldberg v. Sweet, 488 U.S. 252, 260-61, 109 S.Ct. 582, 588, 102 L.Ed.2d 607 (1989). It is an approximation of a corporation's income that is reasonably related to the taxing state.

Minnesota's combined reporting method requires each member of a unitary business engaged in business in Minnesota to file reports disclosing the net income of the entire unitary business. For purposes of determining the net income of the unitary business and the factors to be used in the apportionment of its net income, only the income and apportionment factors of domestic members of the unitary business are included in the combined reports. SeeMinn.Stat. § 290.19, subd. 1(2)(a) (1986). The net income of these domestic members of the unitary business remains unchanged when intragroup transfers, such as interest and royalty payments, occur. See id. § 290.34, subd. 2 (1986) ("All intercompany transactions between [domestic] companies which are contained in the combined report shall be eliminated."). In contrast, neither the net income nor the apportionment factors--property, payroll, and sales--of a foreign member of the unitary business are included in the combined reports; rather, foreign members of the unitary business use a "separate entity" or "arm's length" method of reporting. ⁴ Id. As a result, only interest and royalty payments made by the foreign members of the unitary business to the domestic members of the unitary business are included in the combined report because these payments are considered income to the domestic members. See id. § 290.01, subd. 20 (1986). This inclusion of the foreign members' interest and royalties payments in the combined report without taking into consideration the foreign members' property, payroll, and sales is at the heart of Caterpillar's appeal.

In December 1993, Caterpillar filed amended Minnesota excise tax returns claiming refunds for the tax years 1979-81 and 1985-87. In these amended returns, Caterpillar included its foreign unitary business members' property, payroll, and sales in the denominator of the apportionment formula. This had the effect of decreasing the apportionment percentage and, accordingly, Caterpillar's Minnesota tax liability. On May 2, 1994, the Commissioner issued a notice of change to Caterpillar, stating that Caterpillar owed additional tax for the years 1980 and 1985, and was entitled to a refund less than the amount claimed for the years 1979, 1981, 1986, and 1987. Caterpillar filed a protest to the Commissioner's notice of change, claiming that Minnesota's taxing system unconstitutionally discriminated against interest and royalty payments made by foreign members of Caterpillar's unitary business to Caterpillar and its domestic subsidiaries in violation of the Foreign Commerce Clause of the United States Constitution. The Commissioner denied Caterpillar's protest and Caterpillar appealed to the Minnesota Tax Court. The tax court heard the parties' cross-motions for summary judgment, found that no discrimination existed, and granted the Commissioner's motion.

In reviewing findings of fact made by the tax court, this court determines whether sufficient evidence exists to support the tax court's decision. Carlson v. Commissioner of Revenue, 517 N.W.2d 48, 51 (Minn.1994). However, we freely review the tax court's conclusions of law, id.; Nagaraja v. Commissioner of Revenue, 352 N.W.2d 373, 376 (Minn.1984), and Caterpillar's appeal raises purely legal questions. A taxpayer who challenges a state tax statute under the Foreign Commerce Clause carries the burden of proving that discrimination exists. See Hughes v. Oklahoma, 441 U.S. 322, 336, 99 S.Ct. 1727, 1736, 60 L.Ed.2d 250 (1979); Norton Co. v. Department of Revenue, 340 U.S. 534, 537, 71 S.Ct. 377, 380, 95 L.Ed. 517 (1951) ("[A] taxpayer claiming immunity from a tax has the burden of establishing his exemption."). "The power of this court to declare a statute unconstitutional is to be exercised only when absolutely necessary and with extreme caution." Miller Brewing Co. v. State, 284 N.W.2d 353, 356 (Minn.1979) (citation omitted). Accordingly, we will uphold a statute unless the challenging party demonstrates that it is unconstitutional beyond a reasonable doubt. Olson v. Ford Motor Co., 558 N.W.2d 491, 496 (Minn.1997) (citation omitted).

The Commerce Clause states that "[T]he Congress shall have Power * * * To regulate Commerce with foreign Nations, and among the Several States * * * ." U.S. Const. art. I, § 8, cl. 3. Although the Commerce Clause expressly gives Congress the power to regulate commerce with foreign nations and among the states, the Clause also contains an implied negative command, known as the "dormant" Commerce Clause, which prohibits states from discriminating against foreign trade even where Congress has failed to legislate on the subject. See Oklahoma Tax Comm'n v. Jefferson Lines, Inc., 514 U.S. 175, 178, 115 S.Ct. 1331, 1335, 131 L.Ed.2d 261 (1995); see also Laurence H. Tribe, American Constitutional Law 469 (2d ed. 1988) ("Limits on state authority to tax foreign commerce are implicit in the commerce clause's grant of congressional power to regulate foreign commerce."). In Complete Auto Transit v. Brady, 430 U.S. 274, 97 S.Ct. 1076, 51 L.Ed.2d 326 (1977), the United States Supreme Court adopted a four-part test to determine whether a state's tax system violates the Commerce Clause. To pass constitutional muster, a state tax must: "[be] applied to an activity with a substantial nexus with the taxing State, * * * [be] fairly apportioned, * * * not discriminate against interstate commerce, and * * * [be] fairly related to the services provided by the State." Id. at 279, 97 S.Ct. at 1079. If the state tax fails any part of this test, then the tax is unconstitutional under the Commerce Clause. Id.

When foreign commerce is involved, additional scrutiny is required. In Japan Line, Ltd. v. County of Los Angeles, 441 U.S. 434, 99 S.Ct. 1813, 60 L.Ed.2d 336 (1979), the Supreme Court directed that, when dealing with foreign commerce, in addition to the four-part Complete Auto test, the court must inquire as to whether the tax, notwithstanding apportionment, created an "enhanced risk of [international] multiple taxation," id. at 446, 99 S.Ct. at 1820, and must also ask whether the tax prevents the federal government from "speaking with one...