Cooper Industries, Inc. v. Indiana Dept. of State Revenue, 49T10-9406-TA-00166

• Decision Date: 27 November 1996
• Docket Number: No. 49T10-9406-TA-00166,49T10-9406-TA-00166
• Citation: 673 N.E.2d 1209
• Parties: COOPER INDUSTRIES, INC., Cooper CPS Corporation, Cooper Power Systems, Inc., McGraw Edison Company, and Cooper Turbocompressor, Inc., Petitioners, v. INDIANA DEPARTMENT OF STATE REVENUE, Respondent.
• Court: Indiana Tax Court

Page 1209

673 N.E.2d 1209

COOPER INDUSTRIES, INC., Cooper CPS Corporation, Cooper Power Systems, Inc., McGraw Edison Company, and Cooper Turbocompressor, Inc., Petitioners, v. INDIANA DEPARTMENT OF STATE REVENUE, Respondent.

No. 49T10-9406-TA-00166.

Tax Court of Indiana.

Nov. 27, 1996.

Larry J. Stroble, Barnes & Thornburg, Indianapolis, for Petitioners.

Pamela Carter, Attorney General of Indiana and Joel Schiff, Deputy Attorney General, Indianapolis, for Respondent.

FISHER, Judge.

Petitioners are a group of corporations operating as a unitary business. In 1988, the common parent of the group filed its federal income tax return on a consolidated basis. For purposes of Indiana income taxes, however, the parent and those member corporations with ties to Indiana used the combined reporting method. Also in 1988, the parent sold two subsidiaries and, as required by federal regulations, included the "excess loss account" income associated with those entities in its federal consolidated taxable income. Inasmuch as Indiana income taxes begin with the taxpayer's federal taxable income, the Department decided that Petitioners were required to include the excess loss account income in Indiana adjusted gross income. Petitioners challenge that determination. This Court holds that excess loss

account income from a consolidated federal return does not constitute income for the purposes of a combined Indiana return.

STATEMENT OF FACTS AND BACKGROUND

The facts are not in dispute. Petitioners are Cooper Industries, Inc. and its domestic subsidiaries, Cooper CPS Corporation, Cooper Power Systems, Inc., McGraw Edison Company, and Cooper Turbocompressor, Inc. (collectively, the "Affiliates"). ¹ For the years at issue, these companies were engaged together in the business of manufacturing, distributing, and marketing various electrical, automotive, and industrial products and equipment. The enterprise also involved two oil rigs, incorporated as Petdrill, Inc. and Seadrill, Inc. (collectively, the "Rig Companies"), operating in the Gulf of Mexico. Trans. at 4. Both Petdrill and Seadrill recorded net operating losses for most of the years relevant to this appeal. Stip. at 5.

Beginning in 1985 and continuing through 1988, Cooper Industries filed its Indiana income tax returns on a combined basis, joined by the Affiliates, the Rig Companies, and approximately thirty other related companies. Id. at 2-4, 8. The combined reporting method is an alternative to Indiana's standard three-factor apportionment scheme. By this method, a group of corporations operating as a unitary business may aggregate their earnings before apportionment. ² The parties stipulated that Petdrill and Seadrill were included in Petitioners' combined filings although they did not file individual Indiana returns. Id. at 8.

At the same time Petitioners were filing on a combined basis in Indiana, Cooper Industries was filing on a consolidated basis for federal tax purposes. ³ The Internal Revenue Code permits affiliated domestic corporations satisfying certain rules of common ownership to calculate income and tax liability as a single entity. ⁴ See I.R.C. § 1501. Using this method, Cooper Industries was able to deduct the net operating losses generated by the Rig Companies from its federal taxable income during the years at issue. See Treas. Reg. §§ 1.1502-2, -21. ⁵ In order to accurately reflect this tax benefit, however, Cooper Industries was required simultaneously to reduce its bases in the subsidiaries in the In 1993, the Department audited Petitioners for the taxable years 1987 and 1988. During the audit, Cooper Industries asked to exclude the amounts representing excess loss recapture from its 1988 Indiana adjusted gross income. On July 2, 1993, the Department issued its audit reports, disallowing the exclusion, ex. K, ⁸ and Petitioners timely protested the Department's proposed assessments on October 18, 1993, ex. S. On February 23, 1994, an administrative hearing was held in which the protests were consolidated, and on March 22, 1994, the Department issued a Letter of Findings denying the protests. Ex. T. Petitioners timely filed their original tax appeal in this Court on June 20, 1994. ⁹

                amount of losses claimed.  See Treas.  Reg. § 1.1502-32.  Eventually, the bases were reduced to zero, and Cooper Industries was then required to record the losses in what are termed "excess loss accounts."   See Treas.  Reg. § 1.1502-32(e).  Pursuant to Treas.  Reg. § 1.1502-19(a)(1), when Cooper Industries sold the Rig Companies in 1988, the amounts in the associated excess loss accounts were included in its federal taxable income for that year. 6  Stip. at 7-8. 7
                

JURISDICTION AND STANDARD OF REVIEW

This Court properly has jurisdiction over this appeal pursuant to Ind.Code Ann. § 6-8.1-5-1(g) (West Supp.1996). On appeal, this Court reviews final determinations by the Department de novo and is bound neither by the issues presented nor the evidence adduced at the administrative level. Associated Ins. Cos. v. Department of State Revenue, 655 N.E.2d 1271, 1272 (Ind. Tax Ct.1995); see also Ind.Code Ann. § 6-8.1-5-1(h) (West Supp.1996). In this case, the parties have stipulated to all material facts, leaving only a question of law. The sole question presented is whether Cooper Industries' excess loss accounts constituted adjusted

gross income to Petitioners for the purpose of their 1988 Indiana income taxes. ¹⁰

DISCUSSION

The Department makes two arguments in support of its decision. First, the Department contends that under Ind.Code Ann. § 6-3-1-3.5(b) (West 1989), Cooper Industries was required to begin calculating its Indiana adjusted gross income with the figure it reported as taxable income on its 1988 federal income tax form. Since Cooper Industries filed a consolidated return, that figure included the excess loss recapture from the sales of Petdrill and Seadrill. The Department maintains that since the Indiana Code does not specifically direct the taxpayer to subtract excess loss account income from its federal taxable income, the excess loss recapture was properly included in Cooper Industries' Indiana tax base. Second, the Department argues that even if Cooper Industries is entitled to go behind the numbers, excess loss income is like income from the sale of stock and, therefore, was properly included in Cooper Industries' federal taxable income as either "[g]ross income derived from business" or "[g]ains derived from dealings in property" under I.R.C. § 61. The Court is not persuaded by either argument. ¹¹

When faced with a question of statutory interpretation, this Court looks first to the plain language of the statute. Where the language is unambiguous, this Court " 'has no power to construe the statute for the purpose of limiting or extending its operation.' " F.A. Wilhelm Constr. Co. v. Department of State Revenue, 586 N.E.2d 953, 955 (Ind.Tax.Ct.1992) (quoting C & C Oil v. Department of State Revenue, 570 N.E.2d 1376, 1380 (Ind. Tax Ct.1991)). This Court will, of course, consider the entire statutory framework within which the particular statute or provision operates in order to give effect to "every word and clause therein." Id. (quoting Guinn v. Light, 558 N.E.2d 821, 823 (Ind.1990)).

I. INDIANA ADJUSTED GROSS INCOME AND I.R.C. § 63

The Department's argument that the taxpayer must begin calculating its Indiana adjusted gross income with the precise amount the taxpayer reported as taxable income on its federal return misses the mark. The Indiana Code provides that "the term 'adjusted gross income' shall mean .... [i]n the case of corporations, the same as 'taxable income' as defined in Section 63 of the Internal Revenue Code," subject to four adjustments that are not applicable here. ¹² Ind.Code Ann. § 6-3-1-3.5(b). This definition is plain and unambiguous. Indiana adjusted gross income begins with federal taxable income as defined by I.R.C. § 63, not as reported by the taxpayer. Thus, the issue is not what number appears on line 28 of a taxpayer's federal income tax form 1120 but whether a particular item of income was included in taxable income pursuant to I.R.C. § 63.

This approach is supported by the case law. In F.A. Wilhelm, this Court held that if an item of purported income is not included in "taxable income" under I.R.C. § 63, then it is not included in "adjusted gross income" under Ind.Code Ann. § 6-3-1-3.5(b). 586 N.E.2d at 956. In that case, the taxpayer was a subchapter S corporation that had formerly been a subchapter C corporation. Id. at 954. Generally speaking, the gains and losses of such a corporation would not be subject to income tax at the corporate level but would instead pass through to the shareholders. See I.R.C. §§ 1363, 1366. Under I.R.C. § 1374, however, former subchapter C corporations are subject to a special tax on gains arising prior to its subchapter S election, so called "built-in" gains. 47A C.J.S. Internal Revenue § 337 (1996). In Wilhelm, the taxpayer reported its "built-in" gains and paid the § 1374 federal tax but did not report the gains on its Indiana return. 586 N.E.2d at 954. This Court agreed with taxpayer's approach because the "built-in" gains were not included in "taxable income" under I.R.C. § 63 and thus were not included in Indiana adjusted gross income under Ind.Code Ann. § 6-3-1-3.5(b). Id. at 956.

The Department attempts to distinguish Wilhelm on the grounds that in that case this Court relied in part on the fact that Ind.Code Ann. § 6-3-2-2.8 expressly exempted subchapter S corporations from Indiana tax, "notwithstanding any provision of IC 6-3-1 through IC 6-3-7." 586 N.E.2d at 956. The Department points out that this Court reasoned that these "words of exception" demonstrated that the "legislature intended to exempt subchapter S corporations absolutely from the imposition of any tax under the Act regardless of any contrary provision." Id. While this Court did find this language...