Dow Chemical Co. v. Commissioner of Revenue

• Decision Date: 13 June 1979
• Citation: 391 N.E.2d 253,378 Mass. 254
• Parties: The DOW CHEMICAL COMPANY v. COMMISSIONER OF REVENUE.
• Court: United States State Supreme Judicial Court of Massachusetts Supreme Court

Page 253

391 N.E.2d 253

378 Mass. 254

The DOW CHEMICAL COMPANY v. COMMISSIONER OF REVENUE.

Supreme Judicial Court of Massachusetts, Suffolk.

Argued March 7, 1979.

Decided June 13, 1979.

Chester M. Howe, Boston (Maxwell D. Solet, Boston, with him), for the taxpayer.

John E. Bowman, Jr., Asst. Atty. Gen. (S. Stephen Rosenfeld, Asst. Atty. Gen., with him) for the State Tax Commission.

John S. Brown and Debra L. Lay-Renkens, Boston, for Polaroid Corp., amicus curiae, submitted a brief.

Before HENNESSEY, C. J., and QUIRICO, KAPLAN, WILKINS and ABRAMS, JJ. KAPLAN, Justice.

The Dow Chemical Company, a Delaware corporation conducting business in the Commonwealth, contends that the Commissioner of Revenue, in calculating the taxable net income of the corporation for the year 1969 for purposes of the corporate excise, unlawfully included therein certain items deriving from income of controlled foreign ¹ subsidiaries. This resulted in an assessment of additional tax which Dow seeks to recover by the present appeal.

I. Statement. The facts are stipulated. Dow, with its principal place of business in Midland, Michigan, is engaged in the manufacture and sale of chemicals, metals, plastics, and consumer products in the United States and abroad. It conducts its foreign business through a number of subsidiary corporations incorporated and doing business in Canada, Latin America, Europe, Africa, and the Pacific area. Reflecting these foreign activities, Dow included in gross income on its Federal income tax return for the taxable year ended December 31, 1969, the first two items which, in their bearing on the State tax, are the subject of the present dispute.

The first, in an amount of $8,539,158, represented Dow's "Subpart F income" as defined in § 952 of the Internal Revenue Code. Subpart F income, to be discussed in detail below, may be epitomized as income of certain types earned by a domestic corporation's foreign subsidiaries in a given taxable year, although not necessarily distributed to its shareholders in that year. Dividend distributions in the amount of $6,610,418 were actually received by Dow from its foreign subsidiaries in 1969 but, under Code § 959(a), were excluded from the Federal gross income reported for 1969 because they were comprised in the $8,539,158 of Subpart F income earned and reported for 1969. Additional dividends totalling $3,740,485 were received in 1969 and were also excluded because they had been comprised in Subpart F income earned and reported in years preceding 1969.

Second, Dow included in Federal gross income an amount of $411,256 under Code § 78, representing the foreign taxes paid or deemed paid by its subsidiaries on Subpart F income. This "foreign tax gross-up" is included in gross income in order to ensure proper calculation of the foreign tax credit.

It is agreed that Dow's treatment of both Subpart F income and foreign tax gross-up was appropriate under the Federal Code.

Dow has been qualified to do business in the Commonwealth since 1947. In the taxable year 1969, it had Massachusetts sales of $36,616,802; its ninety-three Massachusetts employees received $1,136,034 in salaries or other compensation; and it owned real and tangible personal property in the Commonwealth of a value of $2,410,588.

On its 1969 State corporate excise return, filed on October 15, 1970, Dow included Subpart F income and foreign tax gross-up in gross income, just as it had on its corresponding Federal return. At the same time it deducted both items as dividends pursuant to G.L. c. 63, § 38(A )(1). Purporting to act under the same provision, it deducted a third item, the $3,740,485 representing dividends actually received in 1969 but earned and included in Subpart F income reported in the Commonwealth in previous years.

In 1973 the Department of Corporations and Taxation assessed Dow an additional $13,983.87 of tax: $10,873.72 represented the increase of tax caused by disallowance of the three claimed deductions, and the remainder was interest on that increment. Dow paid the assessment and then applied to the State Tax Commission (now designated the Commissioner of Revenue, St.1978, c. 514) for an abatement in the same amount. The application was denied on June 13, 1975. Dow filed a timely appeal to the Appellate Tax Board which, without opinion, affirmed the decision of the Commission. Dow appeals to this court.

II. Summary of Conclusions. We reverse in part and affirm in part. Although both Subpart F income and foreign tax gross-up were properly included in Massachusetts gross income, they were deductible as dividends under G.L. c. 63, § 38(A)(1). However, the claimed deduction for dividends actually received in 1969 was properly disallowed.

We reason as follows. The corporate excise adopts the Federal definition of gross income but, to determine taxable net income, allows a deduction for "dividends" included in net income in the taxable year. Subpart F income is included in Federal gross income; and there is no obstacle to the Legislature's treating the earned income of a foreign corporation as income taxable to its domestic parent, even if the parent chooses not to have that income distributed in the taxable year. Subpart F income must therefore be included in Massachusetts gross income. But that income is included in gross income only because it is treated federally as if it had been currently distributed; it should be similarly treated under State law and deductible as a dividend. Disallowance of a dividend deduction for undistributed Subpart F income would in fact prevent the taxpayer from ever receiving a deduction for that income since it could not be included in income when actually distributed; the disallowance would thus subvert the statutory purpose of preventing multiple taxation of corporate income.

The foreign tax gross-up on Subpart F income represents no gain to the taxpayer; it is a fictional Federal addition to gross income designed to help compute the Federal foreign tax credit. But its Federal treatment as a dividend included in income carries over to the State law, so that it should be included in gross income for the State purpose and deducted as a dividend.

Finally, dividends actually received in the taxable year but comprised in Subpart F income in previous years may not be deducted. Inclusion in net income in the taxable year, as noted above, is a prerequisite for the dividend deduction.

III. Discussion. This case involves the interaction of three statutory schemes: the Massachusetts corporate excise, G.L. c. 63, §§ 30-52; the Subpart F provisions of the Code, §§ 951-964; and the provisions relating to the foreign tax credit, Code §§ 78, 901-908, 960. Exposition is necessarily lengthy although the principles guiding decision are not complicated.

A. The Corporate Excise. By St.1966, c. 698, our corporate excise was substantially rewritten to provide new methods of determining taxable net income and apportioning that income to Massachusetts. ² The income component of the excise is determined by calculating gross income, applying certain deductions, allocating the resulting figure to Massachusetts through an apportionment formula, and multiplying the product by a percentage specified in G.L. c. 63, § 39. Gross income for the excise is "gross income as defined under the provisions of the Federal Internal Revenue Code, as amended and in effect for the taxable year" (with exceptions not relevant here). G.L. c. 63, § 30(5)(a ). Net income is obtained by subtracting from gross income the deductions allowed by the Federal Code, except that the Federal deduction for dividends received (confined to 85% Of dividends received from domestic corporations, Code § 243) is not taken over as such in the State law; nor are the Federal deductions for losses sustained in other years, or for taxes imposed by other States or foreign countries allowed by the State law. The State law does not allow the credits permitted by the Federal Code; this applies to the foreign tax credit as described in Code §§ 901, 902, and 960.

To determine State taxable net income, however, certain additional deductions are permitted by the State law. Dividends may be deducted if they were included in net income under the scheme described above G.L. c. 63, § 38(A )(1) this deduction is not confined as under Code § 243. ³

The taxable net income thus finally attained is apportioned to Massachusetts through use of a commonly adopted ⁴ formula measuring the taxpayer's values in the Commonwealth in relation to its values world-wide. Some such apportionment is constitutionally required in order that "the income attributed to the State for tax purposes . . . be rationally related to 'values connected with the taxing State.' " Moorman Mfg. Co. v. Bair, 437 U.S. 267, 273, 98 S.Ct. 2340, 2344, 57 L.Ed.2d 197 (1978), quoting from Norfolk & W.R.R. v. State Tax Comm'n, 390 U.S. 317, 325, 88 S.Ct. 995, 19 L.Ed.2d 1201 (1967). See State Tax Comm'n v. John H. Breck, Inc., 336 Mass. 277, 144 N.E.2d 87 (1957). ⁵ Under G.L. c. 63, § 38, taxable net income is multiplied by the average of fractions representing (i) the corporation's total sales within the State divided by its total sales world-wide; (ii) the value of the corporation's real and tangible personal property owned, rented, or used in the Commonwealth divided by the value of its like world-wide property; and (iii) the amount of compensation paid in the Commonwealth divided by the amount paid world-wide. If in a particular case these "allocation and apportionment provisions . . . are not reasonably adapted to approximate the net income derived from business carried on within th(e) Commonwealth," the taxpayer may proceed under G.L. c. 63, § 42, to attempt to use another method shown to be more reasonable. See Becton, Dickinson & Co. v. State Tax Comm'n, --- Mass. --- ^A, 372 N.E.2d 1254 (1978).

To return to the current facts: After deducting Subpart F...