Medicine Shoppe Intern. v. Director of Rev.

• Court: Missouri Supreme Court
• Writing for the Court: Michael A. Wolff
• Citation: Medicine Shoppe Intern. v. Director of Rev., 156 S.W.3d 333 (Mo. 2005)
• Decision Date: 25 January 2005
• Docket Number: No. SC 85781.,SC 85781.
• Parties: MEDICINE SHOPPE INTERNATIONAL, INC., Respondent, v. DIRECTOR OF REVENUE, Appellant.

156 S.W.3d 333

MEDICINE SHOPPE INTERNATIONAL, INC., Respondent, v. DIRECTOR OF REVENUE, Appellant.

No. SC 85781.

Supreme Court of Missouri, En Banc.

January 25, 2005.

Jeremiah W. (Jay) Nixon, Atty. Gen., James R. Layton, State Solicitor, Jefferson City, for Appellant.

Richard E. Lenza, William B. Prugh, Kansas City, for Respondent.

MICHAEL A. WOLFF, Judge.

Introduction

The director of revenue urges the Court to overturn its 21-year-old decision in Brown Group, Inc. v. Administrative Hearing Commission, 649 S.W.2d 874 (Mo. banc 1983), interpreting a corporate tax statute. The Court's decision, however, has been followed these past 21 years the judicial interpretation has become woven into the fabric of the statute, its interpretation has been incorporated into the director's taxation forms, and the statutory provision has been left untouched by the General Assembly.¹

An incorrect or otherwise undesirable interpretation of a statute can be changed by the General Assembly. The General Assembly's inaction has sometimes been interpreted to be approval of the Court's reading of a statute.² Legislative inaction, however, can just as well mean that the forces arrayed in favor of changing the law are matched by the forces against changing it. In truth, the match does not have to be an even one, for the legislative process in our republican form of government is designed more to prevent the passage of legislation than to encourage it.³ An incorrect judicial interpretation of a statute may also stand simply because the legislature has paid no attention to it. Thus, it is speculative to infer legislative approval from legislative inaction.⁴

In addition to seeking legislative change of an incorrectly interpreted statute, a party in a subsequent case may ask the court to re-examine and overrule its previous case. The doctrine of stare decisis — to adhere to decided cases — promotes stability in the law by encouraging courts to adhere to precedents. But, the adherence to precedent is not absolute, and the passage of time and the experience of enforcing a purportedly incorrect precedent may demonstrate a compelling case for changing course. American history is replete with examples of instances where experience and the changing needs of society trump adherence to precedent and demonstrate the fallacy of an earlier interpretation.⁵

These considerations come into play in this case, where the director of revenue seeks a judicial overruling of this Court's previous interpretation of the taxation statute at issue in this case — the single-factor apportionment provisions of section 143.451.2.⁶

The statute allows a corporation that has business income from Missouri and from other states to apportion its total business revenue by a formula so as to determine the income that Missouri will tax. Missouri law offers the apportionment statute as an alternative to keeping track, dollar by dollar, of income that has a requisite connection to Missouri so that it can, consistent with the United States constitution, be subjected to Missouri's income tax. See generally Dow Chemical Co. v. Director of Revenue, 834 S.W.2d 742 (Mo. banc 1992); Maxland Development Corp. v. Director of Revenue, 960 S.W.2d 503 (Mo. banc 1998).

The question is whether the corporation can exclude so-called "passive" investment income — earned on non-operating excess funds invested by the corporation's parent company in another state — before applying the formula for determining what portion of its income Missouri may tax.

Expressing the statutory language as a formula, the revenue of a corporation that is subject to Missouri tax equals:

NI x Sw + 1/2 Sp
                     ___________
                        St         Where NI is net income; Sw is
                                   the amount of sales or business
                                   wholly within Missouri; Sp is
                                   the amount of sales or business
                                   partly within and partly outside
                                   Missouri; and St is total sales or
                                   business from all sources
                

The specific question is whether the non-Missouri investment income — earned on money swept from the Medicine Shoppe accounts on a daily basis through an agreement with Medicine Shoppe's corporate parent — should be included in the formula as part of Medicine Shoppe's "net income." This investment income — made under an investment agreement between the Ohio parent and Missouri subsidiary — totals millions of dollars for the tax years in question.

The Investment Agreement

Medicine Shoppe is a Delaware corporation with its headquarters in St. Louis. All of Medicine Shoppe's offices and officers, and all but a couple of its employees, are located in Missouri. Medicine Shoppe is a franchisor of retail pharmacies throughout the United States and provides a system, and services that support that system, for the franchisees to run their retail pharmacy operations. Medicine Shoppe, in 1995, became a wholly owned subsidiary of Cardinal Health, an Ohio corporation with its headquarters in Dublin, Ohio.

After becoming a Cardinal Health subsidiary, Medicine Shoppe entered into an investment agreement with its corporate parent in 1997. Under the agreement, any funds in Medicine Shoppe's bank accounts at the end of each day in excess of those needed for operating expenses are transferred to a Cardinal Health "corporate concentration account."⁷ Cardinal Health invests the funds in this account for Medicine Shoppe's benefit. The investable funds remain the assets of Medicine Shoppe, but Cardinal Health has control over the funds in the account and the investment decisions. Cardinal Health pays Medicine Shoppe interest on the invested funds at a rate of return of 7.72% per annum that is credited to the investable funds account on a monthly basis.

Medicine Shoppe's Missouri Income Tax Returns

The income tax periods at issue are July 1, 1998, through June 30, 1999 ("1998"), July 1, 1999, through June 30, 2000 ("1999") and July 1, 2000, through June 30, 2001 ("2000"). For 1998, 1999 and 2000, Medicine Shoppe's income was included in consolidated federal income tax returns that Cardinal Health filed. Medicine Shoppe filed separate Missouri returns and separate returns in other states.

Missouri law, as noted, allows a corporation doing business within and without Missouri alternative methods to allocate and apportion its income for Missouri income taxation. On its 1998, 1999 and 2000 Missouri income tax returns, Medicine Shoppe calculated its taxable income by using the single-factor apportionment method of section 143.451.2(2)(b). Medicine Shoppe classified and reported the interest on its investments through its agreement with Cardinal Health as non-Missouri source income that was not subject to Missouri's taxation and, hence, was not included in the apportionment formula.

The director of revenue disallowed the classification of the interest as non-Missouri source income and issued notices of deficiency for 1998, 1999 and 2000. Medicine Shoppe timely protested the notices of deficiencies and timely appealed the director's final decisions to the Administrative Hearing Commission. This Court has jurisdiction. Mo. Const. art. V, sections 3 and 18.

Non-Missouri Source Investment Income

The language of section 143.451 is clear that only income from sources entirely within or partially within Missouri is subject to Missouri corporate income taxation. "The source of income has been defined as the place where the income was produced." Bass Pro Shops, Inc. v. Director of Revenue, 746 S.W.2d 97, 98 (Mo. banc 1988). Under the source of income concept, income produced or sourced outside Missouri is excludable from income subject to Missouri taxation.

Two early cases involving Union Electric's non-Missouri source income give background to this Court's decision in Brown Group in 1983, though neither case involved the single-factor apportionment statute. In Union Electric Co. v. Coale, 347 Mo. 175, 146 S.W.2d 631, 635 (1940) (Union Electric I), this Court held that dividends from stock in foreign corporations that had no capital or business operation in Missouri were not subject to Missouri income tax for 1936 because they were not Missouri source income. The Court held that the source of income is the place where it was produced and that the income in question was not produced in this state. Id.

Brown Group, Inc. v. Administrative Hearing Commission, 649 S.W.2d 874, applied the Union Electric cases to the single-factor apportionment formula and directly addressed the question of whether certain non-Missouri source income should be excluded from the net income amount in the formula. At issue in that case was Brown Group's royalty income, paid by a Japanese corporation for the use of trade names, shoe designs and shoe patterns developed by a wholly-owned subsidiary of Brown Group. This Court directly addressed the director's argument — which is the same as the argument in this case — that "when a taxpayer elects under sec. 143.451.2(2) to apportion income using the single factor formula it is precluded from allocating any of its income prior to apportionment and that the legislature intended to levy and apportion tax upon the entire net income." Id. at 879.

Brown Group relied on A.P. Green Fire Brick Co. v. Missouri State Tax Commission, 277 S.W.2d 544 (Mo.1955), to determine what is non-Missouri source income — the "source of income" is the place in which the trademarks, trade names and manufacturing processes are used and the income produced. Id. at 547. That means, the Court said, that the source of Brown Group's income from royalties from a Japanese company were wholly outside Missouri, as the trade names and manufacturing processes were used and the income was produced in Japan and other foreign countries. "Since the royalties were a source of income wholly without Missouri," this Court held, "they do not figure in the taxing formula."⁸ The kind of income...