Hamich, Inc. v. State By and Through Clayburgh

• Decision Date: 03 June 1997
• Docket Number: No. 960330,960330
• Parties: HAMICH, INC. and Debbon, Inc., Petitioners, Appellees and Cross-Appellants, v. STATE of North Dakota, By and Through its Tax Commissioner, Richard S. CLAYBURGH, Respondent, Appellant and Cross-Appellee. Civil
• Court: North Dakota Supreme Court

Page 640

564 N.W.2d 640

1997 ND 110

HAMICH, INC. and Debbon, Inc., Petitioners, Appellees and Cross-Appellants, v. STATE of North Dakota, By and Through its Tax Commissioner Richard S. CLAYBURGH, Respondent, Appellant and Cross-Appellee.

Civil No. 960330.

Supreme Court of North Dakota.

June 3, 1997.

Jay H. Fiedler (argued), of Pearson, Christensen, Larivee, Clapp, Fiedler & Fischer, Grand Forks, for petitioners, appellees and cross-appellants.

Donnita Ann Wald (argued), Special Assistant Attorney General, Tax Department, Bismarck, for respondent, appellant and cross-appellee.

NEUMANN, Justice.

¶1 The State, by and through the Tax Commissioner, appeals from a judgment holding taxpayers Hamich, Inc., and Debbon, Inc., were denied equal protection under the state and federal constitutions by the Commissioner's requirement that they file their state corporate income tax returns for tax years 1986 through 1991 using the single entity method rather than the combined report method they preferred. Hamich and Debbon cross-appeal from an order denying their request for attorney fees. We conclude the Commissioner had the statutory authority to impose the single entity filing requirement for those tax years, the requirement is not contrary to public policy, and the requirement did not violate the taxpayers' equal protection rights. We reverse the judgment and affirm the order denying attorney fees.

I

¶2 Debbon, Hamich, and Harma are North Dakota corporations with principal offices in Fargo. Hamich and Harma are wholly-owned subsidiaries of Debbon. The three corporations operate McDonald's Restaurant franchises in Fargo and West Fargo, but conduct no out-of-state business activity. Each restaurant location has a separate franchise granted by McDonald's Corporation and must separately account for its operations. Franchise fees paid to McDonald's Corporation are calculated separately based on each franchise's business activity.

¶3 For federal income tax purposes, Debbon filed consolidated federal corporate income tax returns for tax years 1986 through 1991. Debbon reported the net income of the consolidated group under the methods permitted for parent and subsidiary-controlled corporations under federal law. See 26 U.S.C.A. § 1501. Because Harma incurred losses during those tax years, the losses were used to offset the combined federal taxable income of the consolidated group.

¶4 For those same tax years, Hamich and Debbon filed their North Dakota corporate income tax returns using the combined report method. Under this method, the taxable income or loss of Debbon and the two corporate subsidiaries were again combined to form the starting point for calculating their North Dakota corporate income tax returns, permitting Hamich and Debbon to use Harma's losses to offset income.

¶5 After an audit, the Commissioner determined Hamich and Debbon improperly filed their returns using the combined report method, and should have instead used the single corporate entity method. Under the single entity method, the income or loss of each separate corporate entity is used as the starting point in computing its North Dakota taxable income, and the loss of a related corporation cannot be used to decrease the taxable income of another related corporation.

¶6 Use of the single entity method resulted in the Commissioner assessing Hamich $2,476 and Debbon $23,235 in additional income taxes, statutory penalties and interest for the tax years involved. Hamich and Debbon protested the additional taxes and filed administrative complaints claiming the Commissioner erred in requiring them to report their North Dakota income using the single entity method. Hamich and Debbon argued the Commissioner's failure to allow use of the combined report method violated the equal protection clauses of the state and federal constitutions, N.D.C.C. Chapter 57-38.1, N.D.C.C. § 57-38-14(6), and N.D.A.C. § 81-03-05.1-08.

¶7 The Commissioner adopted the findings, conclusions and order of the administrative law judge upholding the Commissioner's additional assessments against the corporations. Declining to rule on the constitutional question, see First Bank of Buffalo v. Conrad, 350 N.W.2d 580, 584-585 (N.D.1984), the administrative law judge decided requiring a North Dakota corporation with only North Dakota income to report that income using the single entity method conformed with the statutory scheme. The district court on appeal agreed with the administrative decision that the Commissioner's interpretation of the tax statutes allowed the Commissioner to require Hamich and Debbon to file their returns using the single entity method. The court, however, further ruled:

"[E]qual protection of the United States Constitution and the North Dakota Constitution was not afforded the taxpayers here. While the ... Commissioner ... treated all 100% North Dakota corporations the same as the taxpayers, the Commissioner treated the taxpayers differently than multi-state corporations. All the reasons advanced by the Commissioner for the disparate treatment are simply matters of convenience to the Commissioner. None of the reasons satisfies the 'rational relationship test.' The treatment of the taxpayers is 'rational' in the sense that it is good for the government to do things efficiently. Mere convenience, however, is not a sufficient government interest to allow unfair treatment of taxpayers.

"The legislative history of § 57-38-14, N.D.C.C., clearly recognizes that dissimilar treatment of North Dakota and multi-state corporations is unfair and does not advance any recognized public policy."

¶8 The court reversed the administrative decision and directed the Commissioner to allow Hamich and Debbon to file consolidated tax returns using the combined report method for tax years 1986 through 1991. The court also denied Hamich and Debbon's request for attorney fees under N.D.C.C. § 28-32-21.1, concluding the Commissioner's "position in this matter was substantially justified." The Commissioner appealed from the judgment reversing the administrative decision; Hamich and Debbon cross-appealed from the order denying their request for attorney fees.

II

¶9 The facts are undisputed. Because only questions of law are involved, the Commissioner's decision is fully reviewable by this court. See Intern. Minerals & Chemical v. Heitkamp, 417 N.W.2d 791, 792 (N.D.1987); N.D.C.C. § 28-32-19(1), (2) and (6).

A

¶10 A tax is imposed under N.D.C.C. § 57-38-30 "upon the taxable income of every domestic and foreign corporation received from the sources described" in N.D.C.C. §§ 57-38-12, 57-38-13, and 57-38-14. "Taxable income" is defined in N.D.C.C. § 57-38-01(8) as "the taxable income as computed for a[ ] ... corporation for federal income tax purposes under the United States Internal Revenue Code of 1954, as amended, plus or minus such adjustments as may be provided by this act and chapter or other provisions of law." N.D.C.C. § 57-38-32 further requires "[e]ach corporation that receives income from the sources designated in section 57-38-30, whether or not required to file an income tax return pursuant to the provisions of the United States Internal Revenue Code of 1954, as amended, shall, unless exempted by the provisions of section 57-38-09, make a return in such form as the tax commissioner may prescribe, stating specifically such facts as the tax commissioner may require for the purpose of making any computation required by this chapter."

¶11 The parties dispute the Commissioner's authority under N.D.C.C. § 57-38-14. Section 57-38-14 provides:

"Allocation in special cases. In the special cases mentioned in this section, the following principles may be applied in allocating corporate income:

"1. Any corporation organized under the laws of North Dakota and subject to a tax under the provisions of this chapter, which maintains no regular place of business outside this state, except a statutory office, must be taxed upon its entire net income.

* * * * * *

"3. Any corporation liable to report under this chapter and owning or controlling, either directly or indirectly, substantially all of the voting capital stock of another corporation, or of other corporations, may be required to make a consolidated report showing the combined net income, such assets of the corporation as are required for the purposes of this chapter, and such other information as the tax commissioner may require, but excluding intercorporate stock holdings and intercorporate accounts.

"4. Any corporation liable to report under this chapter and owned or controlled either directly or indirectly by another corporation may be required to make a report consolidated with the owning company, showing the combined net income, such assets of the corporation as are required for the purposes of this chapter, and such other information as the tax commissioner may require, but excluding intercorporate stock holdings and intercorporate accounts.

* * * * * *

"6. The tax commissioner may permit or require the filing of a combined report where substantially all the voting capital stock of two or more corporations liable to report under this chapter is owned or controlled by the same interests. The tax commissioner may impose the tax provided by this chapter as though the combined entire net income and segregated assets were those of one corporation, but in the computation, dividends received from any corporation whose assets, as distinguished from shares of stock, are included in the segregations may not be included in the net income.

* * * * * *

"8. If it appears to the tax commissioner that the segregation of assets shown by any report made under this chapter does not reflect properly the corporate activity or business done, or the income earned from corporate activity, or from business done in this state because of the character of the corporation's business and the character and location of its assets, the tax...