James v. International Tel. & Tel. Corp.

• Decision Date: 16 August 1983
• Docket Number: No. 63735,63735
• Citation: James v. International Tel. & Tel. Corp., 654 S.W.2d 865 (Mo. 1983)
• Court: Missouri Supreme Court
• Parties: Ray S. JAMES, Director of Revenue, Appellant, v. INTERNATIONAL TELEPHONE & TELEGRAPH CORP., et al., Respondent.

Page 865

654 S.W.2d 865

Ray S. JAMES, Director of Revenue, Appellant, v. INTERNATIONAL TELEPHONE & TELEGRAPH CORP., et al., Respondent.

No. 63735.

Supreme Court of Missouri En Banc.

Aug. 16, 1983.

John Ashcroft, Atty. Gen., Jay Daugherty, Steven H. Akre, Asst. Attys. Gen., Jefferson City, for appellant.

Rene L. Basile, Barbara E. Boettcher, New York City, Raymond E. Shane, St. Louis, for respondent.

WELLIVER, Judge.

The issue in this case is whether long-term capital gains income of respondent International Telephone & Telegraph Corporation (ITT) from the divestiture of four ITT subsidiaries pursuant to a consent decree constitutes "business income" or "nonbusiness income" for purposes of income allocation and apportionment pursuant to § 32.200, art. IV, RSMo 1969. ¹

I

ITT is a Delaware corporation authorized to do business in Missouri. The original ITT parent corporation and its direct subsidiaries engaged in the manufacture and sale of electronics and telecommunications equipment and other goods. Among its products are switching systems, private telephone and telegraph exchanges, answering and recording equipment, microwave radio systems, mobile communications equipment, and industrial heating and ventilation equipment. ITT now operates in more than sixty countries and employs approximately 400,000 persons.

ITT conducts business in Missouri primarily through its Blackburn Division in St. Louis, which manufactures and sells electrical connectors, grounding devices, and other electrical hardware for electrical utilities and contractors.

During the 1960's ITT instituted a corporate acquisition program in order to complement its existing business structure through diversification, stabilization of profits, and maintenance of a high level of profits for the ITT group as a whole. By 1977 ITT had approximately 1,000 subsidiaries, 400 of which were in the United States. The corporations that ITT acquired engaged in five general areas of business: telecommunications, engineered products, consumer products, natural resources, and insurance and finance. Each subsidiary operated independently of ITT, although for a fee, which ITT reported as income, ITT performed accounting, tax, and other services for some of the smaller subsidiaries. Employees of ITT sat on the boards of directors of some of the subsidiaries, but there were no interlocking directorates among corporations in the ITT group.

ITT's acquisition of the Hartford Fire Insurance Company in 1970 resulted in an antitrust suit against ITT by the United States Department of Justice. The suit was settled in 1971 with the entry of a consent decree by which ITT agreed to a scheduled divestiture of several of its subsidiaries in return for dismissal of the antitrust action. ITT settled the suit in order to prevent protracted and costly litigation, assure certainty in the retention of corporate acquisitions, avoid adverse publicity, and eliminate problems with the Department of Justice.

Pursuant to the consent decree ITT sold its stock in Avis Company and Hamilton Life Insurance Company in 1972 and its stock in Avis Corporation and Canteen Corporation in 1973. Those sales produced long-term capital gains for ITT, income that ITT's accountants treated as "extraordinary" because it was not related to the corporation's regular business income. Consequently, ITT treated the income as "nonbusiness income" on its Missouri income tax returns for 1972 and 1973. "Nonbusiness income" is taxable only in the state of the taxpayer's commercial domicile, the principal place from which its business is managed, and in this instance the capital gains would not be taxable in Missouri because ITT's commercial domicile is New York. See § 32.200, art. IV, §§ 1(1)-(2), -(5); 6(3). ITT included the gains from the divestiture on its New York franchise tax return.

The Department of Revenue audited ITT's Missouri income tax returns for 1972 and 1973 and, on the basis of those audits, assessed against ITT additional income tax and interest of $16,876.47 for 1972 and $63,735.79 for 1973, an aggregate of $80,612.26. ITT petitioned for a formal hearing, after which the Director of Revenue affirmed the assessment. The Director reasoned that corporate growth is a basic business purpose, that the acquisition and management of subsidiaries was a regular part of ITT's business, and that as a result the income in question was earned in the regular course of ITT's business.

The State Tax Commission reversed the Director and held that the disputed income was not taxable in Missouri because it "did not arise from a transaction in the regular course of [ITT's] trade or business." The Director appealed the Commission's decision to the circuit court, which affirmed the Commission on the ground that its decision was supported by competent and substantial evidence upon the whole record. See § 536.140(2)(3), RSMo 1978. From that decision the Director appeals. We have jurisdiction because the case involves construction of the Missouri revenue laws. Mo. Const. art. V, § 3. We affirm.

II

"Business income" for purposes of income apportionment under § 32.200 is defined as "income arising from transactions and activity in the regular course of the taxpayer's trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations." § 32.200, art. IV, § 1(1). ² The current revenue regulations attempt to elucidate this general definition by explaining that

[i]ncome of any type or class and from any source is business income if it arises from transactions and activity occurring in the regular course of a trade or business. Accordingly, the critical element in determining whether income is "business income" or "nonbusiness income" is the identification of the transactions and activity which are the elements of a particular trade or business. In general all transactions and activities of the taxpayer which are dependent upon or contribute to the operations of the taxpayer's economic enterprise as a whole constitute the taxpayer's trade or business and will be transactions and activity arising in the regular course of, and will constitute integral parts of, a trade or business.

12 C.S.R. 10-2.075(4) (1977).

The question we must decide is whether the capital gains from the sale of the four subsidiaries constitute taxable "business income." The Director contends that the acquisition of subsidiaries forms an integral part of ITT's business operations, that such acquisitions contribute to the economic welfare of ITT as a whole, and that "if the income is connected with ... activities constituting part of the integrated overall business of the taxpayer, the income is business income subject to apportionment." The general language of the statute is certainly broad, and the regulation purports to expand it even further. We do not believe, however, that it can legitimately be read as broadly as the Director urges.

State taxation of income earned by businesses operating in interstate commerce is necessarily circumscribed by due process constraints. A state may not, consistent with due process, tax income earned outside its borders unless there is "a 'minimal connection' or 'nexus' between the interstate activities and the taxing State, and 'a rational relationship between the income attributed to the State and the intrastate values of the enterprise.' " Exxon Corp. v. Department of Revenue, 447 U.S. 207, 219-20, 100 S.Ct. 2109, 2117-18, 65 L.Ed.2d 66 (1980) (quoting Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 436-37, 100 S.Ct. 1223, 1231, 63 L.Ed.2d 510 (1980)). The first tail of this bifurcated test, the nexus requirement, concerns "whether the state has given anything for which it can ask return." Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444, 61 S.Ct. 246, 249, 85 L.Ed. 267 (1940). In reality there are two distinct nexus requirements: first, there must be a connection between the taxpayer and the taxing state; second, the out-of-state income sought to be taxed must bear a sufficient relationship through the taxpayer to the taxing state. The first nexus requirement is satisfied "if the corporation 'avails itself of the "substantial privilege of carrying on business" within the State.' " Exxon, 447 U.S. at 220, 100 S.Ct. at 2118 (quoting Mobil, 445 U.S. at 437, 100 S.Ct. at 1231). The second nexus requirement finds expression in the unitary business principle, "the linchpin of apportionability in the field of state income taxation." Mobil, 445 U.S. at 439, 100 S.Ct. at 1232. States may legitimately tax income earned outside their borders "so long as the intrastate and extrastate activities [of the taxpayer form] part of a single unitary business." Id. at 438, 100 S.Ct. at 1232. See also Container Corp. of America v. Franchise Tax Board, --- U.S. ----, ----, 103 S.Ct. 2933, 2940, 77 L.Ed.2d 545 (1983); F.W. Woolworth Co. v. Taxation & Revenue Department, 458 U.S. 354, 102 S.Ct. 3128, 3134-35, 73 L.Ed.2d 819 (1982); ASARCO Inc. v. Idaho State Tax Commission, 458 U.S. 307, 102 S.Ct. 3103, 3109-11, 73 L.Ed.2d 787 (1982); Exxon, 447 U.S. at 223, 100 S.Ct. at 2120. For purposes of the unitary business principle, dividends, interest income, and capital gains are treated in the same manner, ASARCO, 102 S.Ct. at 3116, because "[o]ne must look principally at the underlying activity, not at the form of investment, to determine the propriety of apportionability," Mobil, 445 U.S. at 440, 100 S.Ct. at 1233. The second tail of the bifurcated test, the "rational relationship" requirement, prevents a state from unfairly attributing to itself a portion of the taxpayer's income that is "in fact 'out of all appropriate proportions to the business transacted in that State,' ... or has 'led to a grossly distorted result,' ...." Container Corp., 463 U.S. at ----, 103...