Income Tax Protest of Flint Resources, Matter of

Decision Date17 January 1989
Docket NumberNo. 70024,70024
Citation780 P.2d 665,1989 OK 9
PartiesIn the Matter of INCOME TAX PROTEST OF FLINT RESOURCES. FLINT RESOURCES COMPANY, Appellant, v. STATE of Oklahoma, ex rel. OKLAHOMA TAX COMMISSION, Appellee.
CourtOklahoma Supreme Court

Appeal from the Oklahoma Tax Commission.

After the Oklahoma Tax Commission refused to allow the deduction of either the federal "gross up" or foreign taxes from taxable income the appellant/corporation appealed asserting: (1) Inclusion of the "gross up" violates due process; (2) Failure to allow a deduction for foreign taxes contravenes the commerce and due process clauses of the United States Constitution and of the Oklahoma Constitution's uniformity clause; and (3) Interest should be remitted. We find that: (1) Because the appellant was not engaged in a unitary business, inclusion of the federal "gross up" in Oklahoma taxable income violates the due process clauses of the United States and Oklahoma Constitutions. It is deductible pursuant to 68 O.S.1981 § 2358(A)(2); (2) There is no constitutional prohibition against inclusion of foreign taxes in Oklahoma taxable income and no provision for deduction of foreign taxes within the Oklahoma Income Tax Act. Corporations electing to take the federal foreign tax credit rather than a deduction for foreign taxes paid must include the amount representing foreign taxes within Oklahoma taxable income; and (3) Because the inclusion of foreign taxes in Oklahoma taxable income has been adequately foreshadowed, and because no provision exists in the Oklahoma Income Tax Act for its deduction, the remittur of interest is denied. However, because the tax on the foreign "gross up" was unconstitutional, the additional assessment on the "gross up" amount and the interest on the "gross up" is ordered remitted.

AFFIRMED IN PART; REVERSED IN PART.

Henry G. Will, Martin R. Wing and Laurie A. Patterson, Tulsa, for appellant.

Joe Mark Elkouri, Gen. Counsel, and Kris D. Kasper, Asst. Gen. Counsel, Oklahoma Tax Com'n, Oklahoma City, for appellee.

Thomas G. Potts and Marc F. Conley, Tulsa, for amicus curiae.

KAUGER, Justice.

Three questions involving state income tax are presented on appeal: 1) Whether Oklahoma may include "gross up," as taxable income; 1 2) Whether a corporation which has elected to treat payments of foreign income taxes as a credit for federal tax purposes, may deduct such payments from its taxable income under the Oklahoma Income Tax Act, 68 O.S.1981 § 2351, et seq. (Act); and 3) Whether interest should be remitted.

We find: (1) Because the companies were not engaged in a unitary business, taxation of the federal "gross up" violated due process. The "gross up" deduction is within the purview of 68 O.S.1981 § 2358(A)(2), 2 which allows a deduction for any amount exempted from taxation on constitutional grounds. (2) There is no constitutional prohibition against including foreign taxes in Oklahoma taxable income and no provision for deduction of foreign taxes within the Act. Corporations choosing to take the federal foreign tax credit, rather than a deduction for foreign taxes paid, must include the amount representing foreign taxes within Oklahoma taxable income. (3) The inclusion of foreign taxes in Oklahoma taxable income has been foreshadowed by case law. The Oklahoma Income Tax Act does not provide for the deduction. The requested remittur of interest is disallowed insofar as the deduction for foreign taxes is concerned. Because tax on the foreign "gross up" was unconstitutional, the interest and the additional assessment of the gross-up amount must be remitted.

STIPULATED FACTS

The parties stipulated to the following facts: The appellant, Flint Resources Company is an Oklahoma corporation domiciled in Oklahoma. Flint Construction Company of South America (South America) is a wholly owned subsidiary of Flint Resources Company. Flint Construction (Construction), a wholly owned subsidiary of South America, was organized under the laws of Venezuela, and domiciled in Venezuela. In 1980 and 1981, Flint Resources was primarily a holding company owning 100% of the stock of South America. During that time, South America was also primarily a holding company owning 100% of the stock of Construction. The only relationship between Construction and South America was that of parent-subsidiary. Construction did not conduct business or perform services in Oklahoma. During the years 1980 and 1981, the activities of South America and Construction did not constitute a unitary business.

Flint Resources, South America, and Kelley Ranch Trust filed consolidated tax returns for the years 1980 and 1981. Construction paid Venezuelan income taxes of $3,792,954 in 1980 and $3,837,961 in 1981. Construction paid dividends of $500,000 and $275,000 to South America during 1980 and 1981. Income taxes were withheld, which were paid to Venezuela in the amounts of $100,000 in 1980 and $55,000 in 1981.

The tax returns for the tax years 1980 and 1981, reflect that Flint Resources elected to take the foreign tax credit for the amount of Construction's Venezuelan taxes deemed to have been paid by South America as well as for the taxes withheld and paid to Venezuela on the dividends paid to South America. In 1980, Flint Resources' foreign tax credit amounted to $288,822 and in 1981 it totaled $175,885. Because Flint Resources elected to take the foreign tax credit, the corporation was not allowed to deduct the taxes withheld on the dividends paid to South America. Instead, it was required to add a foreign dividend "gross-up" in the amount of $264,533 in 1980, and $190,600 in 1981, as taxable income on its federal returns. Flint Resources reduced the amount of South America's dividend income by the foreign dividend "gross-up" amounts, and it increased its deduction for taxes paid by $100,000 on its 1980 Oklahoma return and by $48,740 on the 1981 Oklahoma return.

On August 3, 1984, the appellee/Oklahoma Tax Commission (Tax Commission) proposed an additional income tax assessment on Flint Resources and its subsidiaries. The assessment was based on a taxable income figure which included the federal foreign dividend "gross-up" amount for the tax years 1980 and 1981. The assessment disallowed deductions for the income taxes withheld by Venezuela on the dividends paid by Construction to South America. The assessment added $14,581 to the amount of Oklahoma taxes owed for 1980 and $9,574 for 1981. Flint Resources paid the assessed taxes under protest including interest. Flint Resources protested the assessment of additional taxes. After a hearing before an administrative law judge, an order was issued recommending denial of the protest. This order, as supplemented, was affirmed by the Oklahoma Tax Commission en banc. Flint Resources appealed pursuant to 68 O.S.1981 § 225(a).

I
A

TAXATION OF THE FEDERAL "GROSS UP" IS UNCONSTITUTIONAL UNLESS THERE IS A UNITARY RELATIONSHIP BETWEEN AN OKLAHOMA CORPORATION'S FOREIGN SUBSIDIARY AND THE STATE OF OKLAHOMA.

The provisions of the Internal Revenue Code governing foreign tax credits and "gross up" calculations were adopted to relieve taxpayers, within stated limits, of the harsh consequences of double taxation, 3 without eliminating federal tax on income from foreign sources. The federal foreign tax credit scheme also precludes a federal taxpayer, who has paid foreign taxes, from taking both a federal tax credit and a deduction for the same expense. 4 American multinational corporations are offered two options in computing federal income tax: they may either deduct income taxes paid to a foreign government from taxable income under 26 U.S.C. § 164(a)(3) (1981); 5 or they may elect to credit that amount against their tax liability under § 901. 6 Pursuant to § 902 7 corporations utilizing the § 901 credit, receiving dividends from foreign subsidiaries, and owning at least 10% of the voting stock of those subsidiaries, are considered to have paid a portion of the foreign taxes actually paid by their foreign subsidiaries. 8 This amount is also treated as a credit against the federal tax due. Section 275 9 disallows any deduction for foreign taxes paid if a corporation has chosen the §§ 901, 902 benefits and credits. Generally, it is more advantageous for a domestic corporation to take the foreign tax credit. The credit for taxes deemed paid reduces dollar for dollar the actual federal tax due. The deduction merely reduces taxable income. 10 If a domestic corporation elects to take the tax credits afforded by §§ 901 and 902, under 26 U.S.C. § 78 (1981), 11 the "gross-up," must be included in the corporation's taxable income.

Although the question of state taxation of the federal "gross-up" is one of first impression in Oklahoma, the United States Supreme Court addressed the issue in F.W. Woolworth Co. v. Taxation & Revenue Dept., 458 U.S. 354, 372-73, 102 S.Ct. 3128, 3139, 73 L.Ed.2d 819, 833 (1982), reh'g denied , 459 U.S. 961, 103 S.Ct. 274, 74 L.Ed.2d 213 (1982). The Court held that unless there was a unitary relationship between a corporation's foreign subsidiary and the taxing state, taxation of "gross-up" violated due process. Other courts considering the issue both before and after Woolworth have reached varying results. 12 Nevertheless, the determinative factor has been the existence or nonexistence of a unitary relationship between the taxing state and the corporation. 13

Recently, in Matter of Income Tax Protest of Ashland Exploration, Inc., 751 P.2d 1070, 1072 (Okla.1988), we defined unitary business. A business is unitary if it operates in more than one state, and if operations conducted in one state benefit or enhance business activities in one or more other states. These activities must be so interdependent and so mutually beneficial that, in effect, they comprise one integral business. Taxation of the federal "gross up" is constitutional if a unitary relationship...

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