Kelvinator, Inc. v. Department of Treasury, Docket Nos. 67472

• Decision Date: 19 October 1984
• Docket Number: 67473 and 67474,Docket Nos. 67472
• Citation: 355 N.W.2d 889,136 Mich.App. 218
• Parties: KELVINATOR, INC., Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee. GIBSON PRODUCTS CORPORATION, Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee. ARMCO, INC., Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee.
• Court: Court of Appeal of Michigan — District of US

Page 889

355 N.W.2d 889

136 Mich.App. 218

KELVINATOR, INC., Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee.

GIBSON PRODUCTS CORPORATION, Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee.

ARMCO, INC., Petitioner-Appellant, v. DEPARTMENT OF TREASURY, Respondent-Appellee.

Docket Nos. 67472, 67473 and 67474.

Court of Appeals of Michigan.

Submitted Nov. 14, 1983.

Decided June 7, 1984.

Released for Publication Oct. 19, 1984.

Law Offices of Benjamin O. Schwendener, Jr. by Benjamin O. Schwendener, Jr. and Richard J. Rastall, Lansing, for Kelvinator, Inc. and Gibson Products Corp.

Dickinson, Wright, Moon, Van Dusen & Freeman by Peter S. Sheldon and Anthony Ilardi, Jr., Lansing, for Armco, Inc.

Frank J. Kelley, Atty. Gen., Louis J. Caruso, Sol. Gen., and Richard R. Roesch and Terry P. Gomoll, Asst. Attys. Gen., for Dept. of Treasury.

Before V.J. BRENNAN, P.J., and KELLY and COOK, ^* JJ.

PER CURIAM.

This consolidated appeal (# 67473 and # 67474 were consolidated with # 67472) comes to this Court on an appeal as of right from the October 1, 1982, Tax Tribunal order denying petitioners' motion for summary judgment and sua sponte granting such in favor of respondent. The three cases involved here were consolidated below and involve the same issues. The original petitions of each petitioner contested several issues; however, all but the three issues presented in this appeal have been settled. Each petitioner herein received an assessment, following an audit, for taxes due for the years 1976 and 1977. The amounts determined by respondent to be due are not relevant to this appeal.

Each petitioner was a Michigan taxpayer during the years 1976 and 1977, the taxable years at issue here. Kelvinator, Inc., and Gibson Products Corporation are wholly owned subsidiaries of White Consolidated Industries, Inc. (White), an Ohio corporation not licensed to do business in Michigan in 1976 and 1977. WCI International Sales Corporation (WCI) is a Delaware based subsidiary corporation of White, also not licensed to do business in Michigan and which is classified for federal income tax purposes as a domestic international sales corporation (DISC) pursuant to Subtitle A, Subchapter N, part IV, Sec. 991 et seq. of the Internal Revenue Code (26 U.S.C. 991 et seq.). Although neither petitioner (Kelvinator or Gibson) is the parent of WCI (they are "sister" corporations), each entered into a DISC export franchise agreement with WCI, whereby the former paid commissions to the latter in exchange for the latter's acting as a selling agent for export items.

Pursuant to the provisions of Sec. 994(a) of the Internal Revenue Code (IRC), the commissions paid by petitioners to WCI were fully deductible in arriving at petitioners' federal taxable income for the years in question.

In preparing their single business tax returns for 1976 and 1977, petitioners calculated their tax base on the basis of their federal taxable income (including a deduction for the commissions paid to WCI). In issuing the assessment, respondent disallowed the deduction of the commissions paid to WCI and required that they be added back to the tax base. The add-back of these commissions is the focus of the instant controversy.

In the petition of Armco, Inc., the petitioner is the parent, sole shareholder of the DISC, Armco Export Sales Corporation (AESC), also a Delaware corporation. As with the case of Kelvinator and Gibson, respondent disallowed, via audit, Armco's deduction of amounts paid to its DISC for commissions. Respondent Department of Treasury construed M.C.L. Sec. 208.9(4)(e); M.S.A. Sec. 7.558(9)(4)(e) as requiring petitioners to add the commissions paid during these two years back to their respective federal taxable incomes to arrive at their tax bases for purposes of the Michigan Single Business Tax (SBT). None of the DISCs involved herein were Michigan taxpayers during the years in question.

On April 16, 1981, Kelvinator moved for summary judgment pursuant to GCR 1963, 117.2(3), asserting that Sec. 9(4)(e) of the Michigan Single Business Tax Act (the act) was designed to provide a taxable base for a DISC which did business in Michigan, not the DISC's parent (Armco) or sister corporation (Kelvinator and Gibson) that happened to do business in this state. Petitioners further argued that "adding back" such commissions would, in effect, force petitioners and their DISCs to report their incomes on a combined basis, contrary to M.C.L. Sec. 208.77 and 208.78; M.S.A. Sec. 7.558(77) and M.S.A. Sec. 7.558(78); that respondent improperly (and administratively) differentiated between buy/sell DISCs (DISCs which buy goods for resale) and commission DISCs (DISCs which are commission agents with no independent property or payroll); and that any ambiguity in the language of the act must be construed in favor of petitioners.

On October 1, 1982, by opinion and order, the Tax Tribunal rejected petitioners' claims and sua sponte entered summary judgment in favor of respondent. Petitioners appeal as of right.

The first question is whether Sec. 9(4) of the Single Business Tax Act, in conjunction with Secs. 991 et seq., of the Internal Revenue Code, requires appellants to "add back" to their business income (and thus their tax base) commissions paid to a domestic international sales corporation.

The DISC tax mechanism is a complex scheme designed to encourage domestic exporters to increase their exports by granting them preferential tax treatment for setting up a qualified DISC. A DISC within the meaning of Sec. 992(a) of the IRC, 26 U.S.C. 992(a), is not subject to income tax, except for transactions to avoid taxation. A commission DISC, as are AESC and WCI, is accomplished by the related corporation's paying of a commission to the DISC for qualified export sales, as provided by I.R.C. Sec. 994. I.R.C. Reg. 1.994-1(d)(2) provides that the amount of commission may not exceed the amount of income which could have been earned under I.R.C. Sec. 994(a) had the export items been sold or leased to the DISC, plus certain expenses. The amount of commission as determined by Sec. 994 is allowed as an ordinary and necessary business expense deduction by the related supplier corporation pursuant to I.R.C. Sec. 162. Pursuant to I.R.C. Sec. 995, income earned by the DISC is deemed to be distributed to the related supplier or shareholder as a taxable dividend in an amount approximating 50 percent of the DISC's taxable income. The remainder of about 50 percent of the DISC's taxable income is tax deferred.

I.R.C. Reg. 1.991-1(b)(1) provides for the determination of taxable income in general:

"Although a DISC is not subject to tax under subtitle A of the Code (other than chapter 5 thereof), a DISC's taxable income shall be determined for each taxable year in order to determine, for example, the amount deemed distributed for that taxable year to its shareholders pursuant to Sec. 1.995-2. Except as otherwise provided in the Code and the regulations thereunder, the taxable income of a DISC shall be determined in the same manner as if the DISC were a domestic corporation which had not elected to be treated as a DISC. Thus, for example, a DISC chooses its method of depreciation, inventory method, and annual accounting period in the same manner as if it were a corporation which had not elected to be treated as a DISC. Any elections affecting the determination of taxable income shall be made by the DISC."

The SBT, on the other hand, is levied upon the adjusted tax base of a person subject to the act. M.C.L. Sec. 208.31; M.S.A. Sec. 7.558(31). The term "tax base" is defined in Sec. 9(1) of the act to mean:

" * * * business income, before apportionment, or allocation as provided in chapter 3, even if zero or negative, subject to the adjustments in subsections (2) to (9)."

The term "business income" is then defined in Sec. 3(3) of the act:

" 'Business income' means federal taxable income, except that for a person other than a corporation it means that part of federal taxable income derived from business activity."

The term "federal taxable income" for single business tax purpose is in turn defined in Sec. 5(3) of the act as follows:

" 'Federal taxable income' means taxable income as defined in section 63 of the internal revenue code."

Section 63 of the IRC provides in part:

"(a) General Rule.--Except as provided in subsection (b), for purposes of this subtitle the term 'taxable income' means gross income, minus the deductions allowed by this chapter, other than the standard deduction allowed by part IV (section 141 and following)."

Finally, Sec. 2(2) of the act provides:

"A term used in this act and not defined differently shall have the same meaning as when used in comparable context in the laws of the United States relating to federal income taxes in effect for the tax year unless a different meaning is clearly required. A reference in this act to the internal revenue code includes other provisions of the laws of the United States relating to federal income taxes."

The provisions directly at issue here are Secs. 9(4)(e) and 9(7)(a) of the act as they existed in taxable years 1976 and 1977. Section 9(4)(e) provided that, to the extent deducted in arriving at federal taxable income, there should be added to the tax base:

"(e) Any deduction or exclusion by a taxpayer due to a classification as a domestic international sales corporation, western hemisphere trade corporation, China trade act corporation or any like special classification the purpose of which is to reduce or postpone the federal income tax liability. This subsection shall not apply to the special provision of sections 805, 815(c)(2)(A), 809, 823(c), and 824(a) of the internal revenue code."

The only exception is that 1977 P.A. 273 amended Sec. 9(4)(e), first sentence, "due to a classification * * * ". The section formerly read, "due to its classification * * * ". Section...