Pemco, Inc. v. Kansas Dept. of Revenue

• Decision Date: 08 December 1995
• Docket Number: No. 73030,73030
• Citation: 258 Kan. 717,907 P.2d 863
• Parties: PEMCO, INC., Appellee, v. KANSAS DEPARTMENT OF REVENUE, Appellant.
• Court: Kansas Supreme Court

Page 863

907 P.2d 863

258 Kan. 717

PEMCO, INC., Appellee, v. KANSAS DEPARTMENT OF REVENUE, Appellant.

No. 73030.

Supreme Court of Kansas.

Dec. 8, 1995.

Syllabus by the Court

1. The interpretation of a statute is a question of law. An appellate court's review of questions of law is unlimited.

2. Rules or regulations of an administrative agency, to be valid, must be within the statutory authority conferred upon the agency. Those rules or regulations that go beyond the authority authorized, which violate the statute, or are inconsistent with the statutory power of the agency have been found void. Administrative rules and regulations, to be valid, must be appropriate, reasonable, and not inconsistent with the law.

3. In an action challenging the validity of a state regulation, the record is examined and it is held that the district court erred in invalidating a regulation of the Department of Revenue (K.A.R. 92-19-72) which interprets a sales tax statute defining entities subject to Kansas sales tax (K.S.A.1994 Supp. 79-3602[a] ) on the ground the regulation was inconsistent with and exceeded the authority of the statute in the claimed particulars.

James Bartle, of Kansas Department of Revenue, argued the cause and was on the briefs, for appellant.

Alan F. Alderson, of Alderson, Alderson & Montgomery, Topeka, argued the cause and was on the brief, for appellee.

McFARLAND, Chief Justice:

This is an appeal by the Kansas Department of Revenue (Department) from the decision of the district court invalidating K.A.R. 92-19-72 on the ground that it exceeded the statutory authority contained in K.S.A.1994 Supp. 79-3602(a). The action arises from the Department's assessment of sales tax against Pemco, Inc.'s, rental of equipment to its wholly owned subsidiary, Clean Water Construction (Clean Water).

The pertinent stipulated facts may be summarized as follows. Pemco is a corporation authorized to do business in Kansas, and only two persons own stock therein. Pemco is the parent of three wholly owned subsidiary corporations: Carrothers, Clean Water, and Triangle Building. Clean Water and Triangle Building operate as building contractors. Pemco owns all of the construction equipment used by both building contractors, which it rents to each.

Triangle Building is an "open shop" which operates mainly in Kansas, a "right to work" state. Clean Water is a union shop which operates mainly in Missouri, where union contracts are generally required. This arrangement allows the two subsidiaries to maintain what is known as a "double-breasted operation," with both an open and a union shop. All three corporations share a single business location, although each pays its own employees. There is a management fee arrangement between the parent and each of the subsidiaries under which no money actually changes hands. An in-house equipment rate has been established which is billed to the renting subsidiary on a monthly basis. The parent company and its subsidiaries file combined income tax returns in Kansas and consolidated federal income tax returns.

This appeal involves a single, narrow question of law--whether K.A.R. 92-19-72 exceeds the statutory authority of K.S.A.1994 Supp. 79-3602(a).

K.S.A.1994 Supp. 79-3602(a) is the first section of the definitional statute of the Kansas Retailers' Sales Tax Act (K.S.A. 79-3601 et seq.) and provides:

" 'Persons' means any individual, firm, copartnership, joint adventure, association, corporation, estate or trust, receiver or trustee, or any group or combination acting as a unit, and the plural as well as the singular number; and shall specifically mean any city or other political subdivision of the state of Kansas engaging in a business or providing a service specifically taxable under the provisions of this act."

K.A.R. 92-19-72, a Department of Revenue regulation, provides:

"Retail sales between related entities. (a) Each interdepartmental transfer of tangible personal property and taxable services between various departments of a single legal entity shall not constitute a sale subject to sales tax.

"(b) Each transfer of tangible personal property and taxable services between separate legal entities for use or consumption, and not for resale, shall be taxable, even though the entities:

(1) Share common principals or ownership and operations;

(2) share the same business location;

(3) file consolidated income tax returns for federal and state income purposes; or

(4) do not enjoy a profit or expense as a result of the transaction.

"When a transaction would be subject to sales tax if the transaction were between two separately owned and operated entities, the commonality of the two entities is irrelevant, and sales tax is imposed on the transaction between the two related entities.

"(c) 'Separate legal entities' shall mean entities which are recognized as individual entities either in fact or at law. Each transfer of tangible personal property and taxable services between separate legal entities for use or consumption, and not for resale, shall include:

(1) Transfers between individuals and partnerships;

(2) transfers between individuals and corporations (3) transfers between individuals and unincorporated associations;

(4) transfers between partnerships and corporations;

(5) transfers between partnerships and unincorporated associations;

(6) transfers between partnerships;

(7) transfers between unincorporated associations and corporations; and

(8) transfers between corporations, whether between sister corporations or parent and subsidiary corporations."

K.A.R. 92-19-72 became effective May 1, 1988.

Pemco's position may be summarized as follows: (1) Pemco and Clean Water are two corporations acting as a unit; (2) two corporations acting as a unit are within the statute's phrase "any group or combination acting as a unit"; and (3) the regulation clearly requires the two corporations to be treated as separate entities for sales tax purposes and thereby exceeds the statute. The district court essentially agreed with Pemco's interpretation.

The Department argues that the regulation is not in conflict with nor does it exceed the statute. A corporation is recognized as a person for sales tax purposes by the statute and is a separate legal entity. The fact that such corporation may be closely affiliated with another corporation does not change its separate person or entity status to that of being part of a group acting as a unit. Therefore, the regulation spelling out that separate legal entities are each separate persons subject to sales tax is not inconsistent with nor does it exceed the statute.

The interpretation of a statute is a question of law. An appellate court's review of questions of law is unlimited. Davis v. City of Leawood, 257 Kan. 512, Syl. p 3, 893 P.2d 233 (1995); State v. Green, 257 Kan. 444, Syl. p 4, 901 P.2d 1350 (1995); see Seabourn v. Coronado Area Council, B.S.A., 257 Kan. 178, Syl. p 1, 891 P.2d 385 (1995).

Administrative regulations have the force and effect of law. K.S.A. 77-425; Jones v. The Grain Club, 227 Kan. 148, 150, 605 P.2d 142 (1980). Administrative regulations, moreover, are presumed to be valid, and one who attacks them has the burden of showing their invalidity. Capital Electric Line Builders, Inc. v. Lennen, 232 Kan. 379, 383, 654 P.2d 464 (1982). Rules or regulations of an administrative agency, to be valid, must be within the statutory authority conferred upon the agency. Those rules or regulations that go beyond the authority authorized, which violate the statute, or are inconsistent with the statutory powers of the agency have been found void. Administrative rules and regulations, to be valid, must be appropriate, reasonable, and not inconsistent with the law. Pork Motel, Corp. v. Kansas Dept. of Health & Environment, 234 Kan. 374, Syl. p 1, 673 P.2d 1126 (1983).

This is an issue of first impression in Kansas, although similar statutes in other states have given rise to considerable litigation as to whether affiliated corporations could avoid sales tax on transactions with each other. Illustrative thereof are Ex parte Capital City Asphalt, Inc., 437 So.2d 1291 (Ala.1983); Rexall Drug Co. v. Peterson, 113 Cal.App.2d 528, 248 P.2d 433 (1952); Montgomery Ward & Co. v. State, Dept. of Revenue, 628 P.2d 85 (Colo.1981); Superior Coal Co. v. Dept. of Finance, 377 Ill. 282, 36 N.E.2d 354 (1941); Bonnar-Vawter v. Johnson, 157 Me. 380, 173 A.2d 141 (1961); Commissioner of Revenue v. Globe Automatic Vending Co., 383 Mass. 886, 421 N.E.2d 1213 (1981); Central Cooling v. Dir. of Rev., State of Mo., 648 S.W.2d 546 (Mo.1982); White Motor Corp. v. Kosydar, 4 O.O.3d 451, 50 Ohio St.2d 290, 364 N.E.2d 252 (1977); Shelburne Sportswear v. Phila., 422 Pa. 199, 220 A.2d 798 (1966); Automobile Club v. Department of Revenue, 27 Wash.App. 781, 621 P.2d 760 (1980); and Southern States Cooperative v. Dailey, 167 W.Va. 920, 280 S.E.2d 821 (1981). See Annot., 64 A.L.R.2d 769, and cases cited therein. Although the various statutes involved in these cases vary and the rationale differs, the common result has been to permit the imposition of sales taxes or their equivalent on transactions between affiliated corporations. See Comment, The Application of Kansas Sales Tax to Transactions Between Affiliated Companies, 42 Kan.L.Rev. 461 (1994), for a careful analysis of the subject.

The legislature could specifically exempt transactions between affiliated companies as have the legislatures of Connecticut and Texas, but it has not done so. See American Totalisator Systems v. Dubno, 210 Conn. 413, 422 n. 12, 555 A.2d 421 (1989); Conn.Gen.Stat. § 12-412(62) (1995); Tex.Tax Code Ann. § 151.346(a) (West 1992).

For convenience, we iterate the statute at this point as follows:

"(a) 'Persons' means any individual, firm, copartnership, joint adventure, association, corporation, estate or trust, receiver or trustee, or any group or combination acting as a unit,...