GTE v. Revenue Cabinet, Com. of Ky.

Decision Date22 December 1994
Docket NumberNo. 94-SC-168-DG,94-SC-168-DG
PartiesGTE and Subsidiaries, Appellants, v. REVENUE CABINET, COMMONWEALTH OF KENTUCKY, Appellee.
CourtUnited States State Supreme Court — District of Kentucky

Bruce F. Clark, Erica L. Horn, Frankfort, Paul H. Frankel, Morrison & Forester, New York City, Scott B. Clark, GTE Corp., Stamford, CT, for appellants.

Kenton L. Ball, Dana Bynum Mayton, Commonwealth of Kentucky, Legal Services, Frankfort, for appellee.

Thomas J. Luber, Holliday Hopkins Thacker, Wyatt, Tarrant & Combs, Louisville, C. Christopher Trower, Timothy H. Gillis, Sutherland, Asbill & Brennan, Atlanta, GA, Thomas A. Brown, Mark F. Sommer, Greenebaum Doll & McDonald, Louisville, for amicus curiae.


This appeal is from a decision of the Court of Appeals which reversed a judgment of the Franklin Circuit Court and held that GTE and Subsidiaries did not have the right to file a combined Kentucky Income Tax Return pursuant to KRS 141.120.

The issue here is whether an interpretation of KRS 141.120 provides GTE and Subsidiaries with the right to file such a combined Kentucky Income Tax Return.

The circuit judge emphasized that the 64 stipulations of fact agreed to by the parties revealed an interlocking interrelationship among the members of GTE. The circuit judge concluded that there was sufficient satisfaction of the "three unities" test addressing unity not only of ownership but also of use and operations so that this case was governed by Armco, Inc. v. Revenue Cabinet, Ky., 748 S.W.2d 372 (1988) in which this Court upheld the reasoning by Revenue then that the net income of Armco and its Domestic International Sales Corporation should be combined because of their unitary nature. The Court of Appeals distinguished this dispute from the DISC situation presented in Armco because the circumstances of GTE did not involve a mere paper corporation such as a DISC.

The appellate panel announced that the post-Armco interpretation of KRS 141.120 in Revenue Policy 41P225 applied despite a contrary reading of the same statute for the previous 16 years from 1972 to 1988 as requiring unitary reporting. The policy permits unitary reporting only if the subsidiaries are a sham or paper corporation with limited viable activities. The Court of Appeals determined that selecting a business structure was the option of the business which must then live with its consequences including any adverse tax results. The Court of Appeals perceived no express statutory mandate for a combined unitary corporate income tax return in the statute. This Court granted discretionary review.

GTE, a New York Corporation, and Subsidiaries, is a large telecommunications service company that operates in all 50 states through a multi-corporate structure consisting of four basic business groups: telephone operations, communication products, electrical products and communication network services. These business groups are vertically integrated and GTE owns all the stock of its subsidiaries. Many management functions, such as long-term planning, public and governmental relations, purchasing, budgeting, financing and advertising are performed centrally. Members of the GTE group share corporate officers and directors. Management level personnel transfer freely among the several corporate members of the GTE group.

This company filed a combined Kentucky Income Tax Return from 1984 to 1987. In 1988, after the adoption of Revenue Policy No. 41P225, the Revenue Cabinet no longer permitted the filing of a combined return by GTE. Although Revenue has apparently abandoned the portion of the policy requiring retroactive application, the foundations of its 1988 policy change remain the subject of this lawsuit. GTE argues that Revenue had a different reading of the same statute for the previous 16 years from 1972 to 1988 but now would allow unitary reporting only if it is a sham or paper corporation with limited viable activities.

The circuit court found that GTE's true business income could not be calculated on the basis of separate tax returns and that GTE's taxable income must be computed in a combined return because of the unitary nature of its operations. A panel of the Court of Appeals reversed the circuit court because it did not believe there was an express statutory mandate for combined unitary corporate income tax returns provided for in KRS 141.120.

In reaching our decision in this matter, we must review very briefly the legal history of this element of the Kentucky tax system. KRS 141.120 has been part of the Tax Code of Kentucky since 1966. In 1972, the Revenue Cabinet began relying on this statute as authority to combine the income of unitary multi-corporate groups. Revenue then started allowing these unitary corporate groups to file a combined tax return. The method used under the Uniform Division of Income for Tax Purposes Act and adopted by the Kentucky legislature required any multi-state business to determine its business income as defined by KRS 141.120(1)(a) from the activities within the various other states and then requires that business to apportion the income to Kentucky using an apportionment factor. The formula considers sales, payroll and property of the group in Kentucky. See KRS 141.120(8). This Court, as well as the United States Supreme Court, has recognized the validity of filing a combined return under UDITPA. From 1972 to 1988, the Revenue Cabinet continuously required and regularly recognized the legal validity of the unitary theory and of combined filing under KRS 141.120. During that time, there were various lawsuits which will be discussed later in this Opinion which influenced Revenue policy. Finally in 1988, Revenue effectively halted the filing of combined returns, citing in Revenue policy 41P225 this Court's unpublished case of V.E. Anderson v. Revenue Cabinet, 87-SC-122-DG, rendered November 5, 1987. It should be understood in discussing that case that all parties recognize it cannot be cited as legal authority pursuant to Civil Rule 76.28(4)(c), but that this Court takes notice of the case as a basis for the conduct of Revenue.

The Revenue Cabinet claims that it adopted the 1988 policy in response to several decisions of this Court: Armco, Inc., supra; Department of Revenue v. Early and Daniel, Ky., 628 S.W.2d 630 (1982); and an unpublished decision of this Court, V.E. Anderson v. Revenue Cabinet, supra. Revenue argues that because of these decisions, unitary combined reporting is applicable only when DISC corporations are involved and the units are sham or paper corporations.

GTE contends that this Court, as well as numerous other jurisdictions, has recognized the propriety of combined reporting and that the adoption by the Cabinet of its 1988 revenue policy was an unlawful abandonment of its previous policy of permitting combined returns. GTE maintains that the failure of the Revenue Cabinet to consider the totality of income of a unitary group when apportioning that income to Kentucky for tax purposes results in a contravention of due process of law principles.


KRS 141.120 and the decisions of this Court authorize multiple corporations engaged in a unitary business to file combined income tax returns.

This Court in Armco, supra, stated that "The unitary theory is a recognized and accepted method of determining the taxable business income of two or more corporations," citing Edison California Stores v. McColgan, 30 Cal.2d 472, 183 P.2d 16 (1947) for the test of a unitary group. That test requires a unity of ownership, use and operations. The circuit court found that the Revenue Cabinet stipulated that GTE met the three-unities test.

Six other states have considered this issue and have construed statutes patterned after UDITPA. Each has held that the statute can be applied to a multi-corporate unitary group so as to allow the unitary group to file a combined state income tax return.

The Revenue Cabinet in Kentucky had for sixteen years, from 1972 to 1988, interpreted the statute as allowing the filing of such combined returns. The other states which have followed the same theory include: Edison California Stores, Inc. v. McColgan, supra; Coca Cola Co. v. Dept. of Revenue, 271 Or. 517, 533 P.2d 788 (1975); Pioneer Container Corp. v. Beshears, 235 Kan. 745, 684 P.2d 396 (1984); Deseret Pharmaceutical Co. v. State Tax Com'n, 579 P.2d 1322 (Utah 1978); and Western Contracting Corp. v. State Tax Com'n, 18 Utah 2d 23, 414 P.2d 579 (1966); Caterpillar Tractor Co. v. Lenckos, 84 Ill.2d 102, 49 Ill.Dec. 329, 417 N.E.2d 1343 (1981); Montana Dept. of Revenue v. American Smelting and Refining Co., 173 Mont. 316, 567 P.2d 901 (1977). The significance of the cases from other jurisdictions is that the statute at issue in each case was virtually identical to KRS 141.120. It should be noted that Arkansas in Land O'Frost, Inc. v. Pledger, 308 Ark. 208, 823 S.W.2d 887 (1992), refused to allow combined filings in the face of a regulation prohibiting such filings. In Kentucky there is no law or regulation prohibiting the filing of combined returns.

The United States Supreme Court has followed a similar interpretation beginning in Butler Brothers v. McColgan, 315 U.S. 501, 62 S.Ct. 701, 86 L.Ed. 991 (1942), and again in Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 103 S.Ct. 2933, 77 L.Ed.2d 545 (1983). The most recent U.S. Supreme Court case affirming the validity of the unitary business principle is Allied-Signal, Inc. v. Director, Div. of Taxation, --- U.S. ----, 112 S.Ct. 2251, 119 L.Ed.2d 533 (1992). See also Barclays Bank, PLC v. Franchise Tax Bd. of Calif., --- U.S. ----, 114 S.Ct. 2268, 129 L.Ed.2d 244 (1994).

The theory of UDITPA apportionment is to insure that the taxpayer is assessed based on income derived from business activity fairly attributable to the taxing state. The intent is to focus on the substance of the activities of the taxpayer rather than the form those business activities...

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