Hutchinson Technology v. Com'r of Revenue, No. A04-1245

• Decision Date: 09 June 2005
• Docket Number: No. A04-1247., No. A04-1245
• Parties: HUTCHINSON TECHNOLOGY, INC., Respondent (A04-1245), Relator (A04-1247) v. COMMISSIONER OF REVENUE, Relator (A04-1245), Respondent (A04-1247).
• Court: Minnesota Supreme Court

698 N.W.2d 1

HUTCHINSON TECHNOLOGY, INC., Respondent (A04-1245), Relator (A04-1247) v. COMMISSIONER OF REVENUE, Relator (A04-1245), Respondent (A04-1247).

Nos. A04-1245, A04-1247.

Supreme Court of Minnesota.

June 9, 2005.

Mike Hatch, Attorney General, Bradford S. Delapena, Assistant Attorney General, James W. Neher, Assistant Attorney General, St. Paul, MN, for Appellant.

Walter A. Pickhardt, Lisa R. Pugh, Faegre & Benson, L.L.P., Minneapolis, MN, for Respondent.

Heard, considered, and decided by the court en banc.

OPINION

ANDERSON, RUSSELL A., Justice.

This case involves claims for refund of Minnesota corporate franchise taxes paid by Hutchinson Technology, Inc. (HTI) for tax years 1995 through 1999, based on its relationship and transactions with its wholly-owned foreign subsidiary, HTI Export, Ltd. (Export). The refund claims are based on HTI's assertion of eligibility for (1) a subtraction in calculating its net income of "royalties, fees, or other like income" accrued or received by HTI from Export, Minn.Stat. ? 290.01, subd. 19d(11) (1998)¹ (the "fees subtraction"); and (2) a deduction from HTI's taxable net income for 80 percent of dividends deemed paid to HTI by Export, Minn.Stat. ? 290.21, subd. 4(a)(1) (2004) (the "dividend-received deduction"). Both tax treatments involve issues relating to Export's status as a "foreign sales corporation" (FSC) under federal tax law and a "foreign operating corporation" (FOC) under Minnesota tax law. The Commissioner of Revenue denied both the subtraction and the deduction for all of the tax years in issue. In a series of three decisions, the Minnesota Tax Court ruled that Export could qualify as both a FSC and an FOC and allowed HTI the fees subtraction. But the court denied HTI the dividend-received deduction and concluded that this denial did not violate the Foreign Commerce Clause of the United States Constitution. We affirm in part and reverse in part.

Minnesota taxes corporate income using a combined reporting method. This means that the income of separate corporations that are engaged in a unitary business is combined for purposes of determining the Minnesota franchise tax. See Caterpillar, Inc. v. Comm'r of Revenue, 568 N.W.2d 695, 696 (Minn.1997)

. Minnesota uses the "waters edge" model of combined reporting, which includes only domestic members of the unitary group in the combined income reporting and excludes foreign members of a unitary business from the combination. See id. at 696 n. 2.² The tax treatments at issue in this case involve two exceptions to the waters edge system of combined tax reporting.

First, Minnesota defined the foreign-incorporated FSCs as domestic subsidiaries and included this one type of foreign-incorporated corporation in the unitary group so that its income would be taxed with its parent's income. Minn.Stat. ? 290.01, subd. 5 (2004); Minn.Stat. ? 290.01, subd. 19c(9) (1998).³ A FSC, created under federal tax law, allowed U.S. exporters to reduce their federal income tax on export-related income if they followed certain requirements under the federal tax code. I.R.C. ? 922(a) (1994).⁴ FSCs had to be incorporated and have certain minimal activities occurring in a foreign country or a United States possession, but they were not required to have any actual operations. See id.

Second, Minnesota chose to exclude the income of one type of domestic corporation from the unitary group?€”the FOC. Minn. Stat. ? 290.17, subd. 4(h) (2004). FOCs are a Minnesota tax entity adopted in 1988 to provide some tax relief for domestic corporations that manufactured goods for export. The income from the FOCs was instead deemed paid to the parent corporation as a dividend. Minn.Stat. ? 290.17, subd. 4(g) (1998). But Minnesota then allowed parent corporations of FOCs to take some income deductions or subtractions for portions of the FOCs' foreign income and for certain expenses. These deductions and subtractions are involved in the case before us.

HTI is a Minnesota corporation that manufactures and sells components for computer hard drives. HTI ran its export sales through Export, as its nonexclusive distributor, in order to maximize federal tax benefits. For the fiscal years beginning September 24, 1994, and ending September 26, 1999 (the tax years in issue), the parties have stipulated that Export was a wholly-owned subsidiary of HTI and was a FSC⁵ under the Internal Revenue Code.

On its Minnesota corporate franchise tax returns for the tax years in issue, HTI claimed a dividend-received deduction under Minn.Stat. ? 290.21, subd. 4(a)(1), on the basis that it could deduct 80 percent of the dividends that Export, as an FOC, was deemed to have paid to HTI under Minn. Stat. ? 290.17, subd. 4(g).⁶ In 2001, the Commissioner denied HTI this deduction for all of the tax years in issue, stating that Export was not an FOC, and assessed HTI additional taxes, with interest and penalties.

HTI appealed to the tax court. HTI contended that Export was an FOC under Minn.Stat. ? 290.01, subd. 6b (1998), because (1) Export was a FSC, and therefore a domestic corporation as defined in Minn. Stat. ? 290.01, subd. 5 (2004); (2) Export was engaged in a unitary business with HTI, a corporation that was taxable in Minnesota; and (3) the average of Export's property and payrolls assigned to locations inside the United States was 20 percent or less than its total property and payroll. HTI contended that it was therefore entitled to the dividend-received deduction as an FOC.

On the preliminary issue of Export's qualification as an FOC, the tax court granted partial summary judgment to HTI, determining that Export qualified as an FOC under the plain meaning of Minn. Stat. ? 290.01, subd. 6b. Hutchinson Tech. Inc. v. Comm'r of Revenue, No. 7398-R, 2003 WL 223405, at *5 (Minn. T.C. Jan. 2, 2003). But even though it determined that Export qualified as an FOC, the court, in a subsequent decision, denied HTI the dividend-received deduction and granted partial summary judgment to the Commissioner because Export was also a FSC. Hutchinson Tech., Inc. v. Comm'r of Revenue, Nos. 7398-R, 7504-R (Minn. T.C. Sept. 15, 2003), available at http://www. taxcourt.state.mn.us/published% 20orders/2003/ hutchinson% 20technology% 20v% 20cor% XXXX-XX-XX% 20.doc. The tax court explained that HTI's eligibility for the dividend-received deduction was controlled by the plain language of Minn. Stat. ? 290.21, subd. 4(e) (1998), which "clearly states that the dividend-received deduction `does not apply if the dividends are paid by an FSC.'" Dividends paid by FSCs, like Export, were therefore expressly excluded from the deduction. The tax court also held that the denial of the dividend-received deduction for FSC dividends did not violate the Foreign Commerce Clause of the United States Constitution because the discrimination was not based on the FSC's place of incorporation, but rather on the FSC's unique nature as "a special type of corporation created and existing solely under the federal tax code."

In 2002, HTI filed amended tax returns claiming the subtraction under Minn.Stat. ? 290.01, subd. 19d(11), for 80 percent of "royalties, fees, or other like income" received by HTI from Export. The Commissioner denied the refund because "some or all of the expenses claimed in the amended returns [did] not qualify as foreign royalties or fees." The Commissioner further stated that "[i]tems such as interest, rents, depreciation, etc. do not constitute `fees.'" HTI appealed to the tax court, which determined that pursuant to Minn.Stat. ? 290.01, subd. 19d(11), HTI was entitled to subtract 80 percent of the fees that it had accrued or received from Export. Hutchinson Tech., Inc. v. Comm'r of Revenue, Nos. 7398-R, 7504-R, 2004 WL 1161427 (Minn. T.C. May 10, 2004), available at http://www. taxcourt.state.mn.us/published% 20orders/2004/ hutchinson% 20v% 20cor% 2005-10-04.doc.

HTI and the Commissioner each petitioned our court for certiorari review, and we consolidated the two cases. We review (1) the Commissioner's appeal of the tax court's ruling that Export was an FOC; (2) the Commissioner's appeal of the tax court's decision allowing HTI to take the fees subtraction; and (3) HTI's appeal of the tax court's decision affirming the denial of the dividend-received deduction and HTI's contention that this denial violates the Foreign Commerce Clause. Our review of tax court decisions is limited. We uphold the tax court's ruling "where sufficient evidence exists for the tax court to reasonably reach the conclusion it did." Green Giant Co. v. Comm'r of Revenue, 534 N.W.2d 710, 711 (Minn.1995) (quoting Am. Ass'n of Cereal Chemists v. County of Dakota, 454 N.W.2d 912, 914 (Minn.1990)). We review de novo the tax court's conclusions of law, including its interpretation of statutes. Chapman v. Comm'r of Revenue, 651 N.W.2d 825, 830 (Minn.2002).

I.

We first examine the tax court's determination of the preliminary issue of whether Export qualified as a "foreign operating corporation" under Minn.Stat. ? 290.01, subd. 6b. The Commissioner contends that the statute was ambiguous and should be construed to reflect legislative intent that FSCs could not qualify as FOCs.⁷

For the tax years in issue, Minn.Stat. ? 290.01, subd. 6b, provided:

The term "foreign operating corporation," when applied to a corporation, means a domestic corporation with the following characteristics:

(1) it is part of a unitary business at least one member of which is taxable in this state; and

(2) either (i) the average of the percentages of its property and payrolls assigned to locations inside the United States and the District of Columbia, excluding the commonwealth of Puerto Rico and possessions of the United States, as determined under Section 290.191 or 290.20, is 20 percent or less; or (ii) it has in effect a valid election under section 936 of the Internal Revenue Code.

There is no dispute that Export satisfied the first...