Caterpillar Inc. v. N.H. Dep't of Revenue Admin.

• Decision Date: 25 October 1999
• Docket Number: No. 97–779.,97–779.
• Citation: 144 N.H. 253,741 A.2d 56
• Court: New Hampshire Supreme Court
• Parties: CATERPILLAR INC. and another v. NEW HAMPSHIRE DEPARTMENT OF REVENUE ADMINISTRATION and another.

144 N.H. 253

741 A.2d 56

CATERPILLAR INC. and another

v.NEW HAMPSHIRE DEPARTMENT OF REVENUE ADMINISTRATION and another.

No. 97–779.

Supreme Court of New Hampshire.

Oct. 25, 1999.

Rath, Young, and Pignatelli P.A., of Concord (William F.J. Ardinger and Brian T. Tucker on the brief), Morrison & Foerster, LLP, of New York, New York (Paul H. Frankel and Craig B. Fields on the brief, and Mr. Frankel orally), Sutherland, Asbill & Brennan, of Washington, D.C. (Jerome B. Libin on the brief), and Daniel J. Schlicksup, of Peoria, Illinois, by brief, for the plaintiffs.

Philip T. McLaughlin, attorney general (Martin P. Honigberg, senior assistant attorney general, on the brief and orally), for the defendants.

Peter S. Garre, of New London, by brief, as amicus curiae.

HORTON, J.

The plaintiffs, Caterpillar Inc. and two of its subsidiaries, Caterpillar Financial Services Corporation and Solar Turbines Incorporated, appeal a Superior Court (McGuire , J.) order granting the cross-motion for summary judgment of the defendants, the State Department of Revenue Administration and its commissioner, in an action challenging the constitutionality of certain provisions of RSA chapter 77–A (1991 & Supp.1998). We affirm.

Caterpillar Inc. is a multinational corporation headquartered in Peoria, Illinois. In each of the tax years at issue, Caterpillar Inc. owned over fifty domestic and foreign subsidiaries and several foreign affiliates. Caterpillar Inc. and all of its subsidiaries engaged in one unitary business. See RSA 77–A:1, XIV. Only the plaintiffs, however, conducted business in New Hampshire and were thus required to file tax returns on their business profits pursuant to RSA chapter 77–A. See RSA 77–A:2 (1991) (amended 1993).

In 1991, the State Department of Revenue Administration (department) audited the plaintiffs' 1987, 1988, and 1989 New Hampshire tax returns and issued a notice of assessment, demanding additional business profits tax payments. The department ordered the plaintiffs to remit the taxes due on royalties and interest received by Caterpillar Inc. from various foreign subsidiaries and affiliates from 1987 through 1989, amounts which the plaintiffs had failed to include as income in their returns. The plaintiffs filed a protest with the department in September 1991, arguing, inter alia , that the manner in which the foreign interest and royalty payments had been taxed violated the Commerce Clause of the Federal Constitution, see U.S. CONST. art. I, § 8, cl. 3, and requesting an alternate method of apportionment. After a hearing in February 1993, the department rejected the plaintiffs' protest on procedural grounds and declined to decide the constitutional issue based on lack of jurisdiction.

The plaintiffs appealed the department's decision to the superior court. See RSA 21–J:28–b, IV (Supp.1998). The parties filed cross-motions for summary judgment with supporting memoranda. After a hearing, the superior court issued an order in October 1997 granting the defendants' motion for summary judgment. This appeal followed.

The parties have stipulated to the underlying facts and agree that this appeal involves only questions of federal constitutional law. We therefore conduct a de novo review of the trial court's decision granting summary judgment in favor of the defendants. Benoit v. Test Systems, 142 N.H. 47, 49, 694 A.2d 992, 993 (1997). The heart of this appeal is whether the water's edge apportionment formula in RSA 77–A:3 (1991) (amended 1991, 1993) violates the Commerce Clause by taxing royalty and interest payments received from foreign subsidiaries of a unitary business without subjecting them to global apportionment.

It is well-established that "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, 73 L.Ed.2d 787 (1982). When a business operates in more than one jurisdiction, its income must be apportioned among those jurisdictions and each State must determine its share of the income. See Container Corp. v. Franchise Tax Bd., 463 U.S. 159, 164, 192, 103 S.Ct. 2933, 77 L.Ed.2d 545 (1983). The Federal Constitution does not impose a particular method upon the States in making this determination. Id. at 164, 103 S.Ct. 2933.

These principles apply when a business is unitary, that is, comprised of several entities among which there is "substantial mutual interdependence." Container Corp., 463 U.S. at 179, 103 S.Ct. 2933 (brackets and quotations omitted). Although there is no universally accepted definition of unitary business, see id. at 167–69, 103 S.Ct. 2933, for constitutional purposes it is minimally "characterized by a flow of value among its components," Kraft Gen. Foods, Inc. v. Iowa Dept. of Revenue and Finance, 505 U.S. 71, 76, 112 S.Ct. 2365, 120 L.Ed.2d 59 (1992). New Hampshire defines unitary business as "one or more related business organizations engaged in business activity both within and without this state among which there exists a unity of ownership, operation, and use; or an interdependence in their functions." RSA 77–A:1, XIV.

"[C]ontributions to income [that] result[ ] from functional integration, centralization of management, and economies ofscale," Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 438, 100 S.Ct. 1223, 63 L.Ed.2d 510 (1980), are difficult to capture on the accounting books when determining total tax liability for a unitary business. See Container Corp. , 463 U.S. at 164, 103 S.Ct. 2933. Further, transfers of value among entities within a unitary business may mask income earned. See Barclays Bank PLC v. Franchise Tax Bd. of Cal., 512 U.S. 298, 305, 114 S.Ct. 2268, 129 L.Ed.2d 244 (1994). In order to ascertain their just proportion of the profits earned by a unitary business entity within their respective jurisdictions, most States with a corporate income tax employ formulary apportionment. See Container Corp., 463 U.S. at 164–65, 103 S.Ct. 2933. See generally Christensen, Formulary Apportionment: More Simple—On Balance Better?, 28 Law & Pol'y Int'l Bus. 1133, 1135 (1997).

Under the apportionment method, the state considers the income generated by all of the corporation's activities, out-of-state as well as in-state, and then apportions a share of such income to the taxing state by means of a formula that compares the taxpayer's in-state activities to all of its activities.

Hellerstein, State Taxation of Corporate Income From Intangibles: Allied Signal and Beyond, 48 Tax L.Rev. 739, 745 (1993). At one time, a number of States, see Barclays Bank PLC, 512 U.S. at 306, 114 S.Ct. 2268, including New Hampshire, calculated taxable income by apportioning the worldwide combined income of the entire unitary group, see Opinion of the Justices, 128 N.H. 1, 5, 509 A.2d 734, 737 (1986). Most States using apportionment have now adopted a variant formula, in which the total combined income to be apportioned is confined to the "water's edge" or geographic boundaries of the United States, even though the scope of the unitary business may cross national borders. See Barclays Bank PLC, 512 U.S. at 306, 114 S.Ct. 2268 ; see RSA 77–A:1, XV, XVI.

New Hampshire's apportionment method operates generally in the following manner: First, the combined net income of the domestic members of the unitary business group is determined (water's edge net income). See RSA 77–A:1, XIII, :2–b. Then the three apportionment factors of property, payroll, and sales are calculated to determine the percent of the group's net income attributable to the State for taxation. See RSA 77–A:3, I. The property factor is determined by dividing the value of the taxpayer's New Hampshire real and personal property (the numerator) by the value of the real and personal property of the water's edge group (the denominator). See RSA 77–A:3, I(a). The payroll and sales factors are similarly calculated. See RSA 77–A:3, I(b), (c). The property, payroll, and sales of the foreign members are not considered in calculating the factors. See RSA 77–A:1, XV, XVI. The three resulting percentages are averaged by combining them and dividing the total by three. See RSA 77–A:3, II(a). This figure is the apportionment percentage, which is multiplied by the water's edge net income, the product of which is the amount of business profits that New Hampshire may tax. See generally RSA 77–A:1, XVI, :2–b, :3.

Royalty and interest payments from one domestic member of the unitary group to another do not change the combined net income of the water's edge group because a receipt to one constitutes a deduction for another. Cf. 26 U.S.C.A. §§ 61, 162 (1988). Such payments, however, are eliminated from the combined sales factor (the denominator) to avoid overstating the water's edge sales activity. See N.H. Tax Form 1120 Specific Instructions For Filing Combined Returns (1988). This is because the combined sales factor is an aggregate of gross receipts and does not account for deductions.

In contrast, royalty and interest payments from a foreign member of the unitary group to a domestic member are treated as if they were made by unrelated businesses. See RSA 77–A:1, VI (defining "gross business income"). The payments are manifested as increases to the net income of the water's edge group and are also included in the combined sales factor since they constitute a portion of the gross sales receipts of the domestic group. See RSA 77–A:1, XIII (defining "combined net income"), :3, I(c). In short, royalty and interest payments of domestic members of a unitary group are subject to apportionment while similar payments by the foreign members to domestic members are taxed without including the foreign property, payroll, and sales in the apportionment factors because their income is excluded from the tax base.

The Commerce Clause of the Federal Constitution provides 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....