Skaarup Shipping Corp. v. Commissioner of Revenue Services

Decision Date15 April 1986
Citation507 A.2d 988,199 Conn. 346
CourtConnecticut Supreme Court
Parties, 77 A.L.R.4th 815 SKAARUP SHIPPING CORPORATION v. COMMISSIONER OF REVENUE SERVICES.

Vernon C. Miller, Jr., for appellant (plaintiff).

Robert L. Klein, Asst. Atty. Gen., with whom, on brief, was Joseph I. Lieberman, Atty. Gen., for appellee (defendant).

Before PETERS, C.J., and ARTHUR H. HEALEY, DANNEHY, CALLAHAN and DOYLE, JJ.

PETERS, Chief Justice.

The issue in this case is whether a corporation that has elected to treat payments of foreign income taxes as a credit for federal tax purposes may claim such payments as a deduction from its taxable income under the Connecticut corporate business tax. The department of revenue services disallowed the deduction and assessed tax deficiencies for the years 1977 and 1978 against the plaintiff, Skaarup Shipping Corporation. The plaintiff took a timely but unsuccessful appeal to the defendant, the commissioner of revenue services. The plaintiff's subsequent appeal to the Superior Court, pursuant to General Statutes § 12-237, 1 resulted in a stipulation of facts by the parties and a request to the court for reservation of the question of law for the consideration and advice of the Appellate Court. The trial court agreed to reserve the question, and this court transferred the reservation here. We answer the reserved question in the negative.

The stipulation reveals the following facts. The plaintiff Skaarup is a New York corporation authorized to do business in Connecticut. Its business is worldwide ocean shipping. During the tax years 1977 and 1978, the plaintiff was a partner in Natomas-Skaarup Marine Sales, a partnership conducting business in the United Kingdom. Because of these activities, the partnership, and the plaintiff as a partner, incurred liability for United Kingdom income taxes.

The plaintiff reported its share of the partnership income and of the United Kingdom income taxes on its 1977 and 1978 federal and state tax returns. 2 The plaintiff elected to treat the United Kingdom taxes as a credit under 26 U.S.C. § 901, 3 even though that election did not provide the plaintiff with a credit in the full amount of the taxes paid. 4 See 26 U.S.C. § 904. 5 As a consequence of its election to treat the taxes as a credit, the plaintiff was barred by Internal Revenue Code §§ 275(a)(4) and 905(a) 6 from taking the taxes as a deduction on its federal tax returns for the years in question. In filing its Connecticut corporation tax returns, the plaintiff deducted in each year the full amount of the United Kingdom taxes that it had paid.

The department of revenue services interpreted General Statutes § 12-217 to disallow the plaintiff's claimed deductions to the extent that they exceeded the foreign tax credits reported on the plaintiff's federal income tax returns. Accordingly, the plaintiff was notified of deficiency assessments for its 1977 and 1978 state tax returns. The plaintiff declined to pay the additional taxes and contested the adverse ruling at a hearing before the director of protests and hearings. The defendant commissioner denied its appeal.

The question upon which the parties seek the advice of this court is as follows: "May the plaintiff corporation deduct, pursuant to [s] 12-217 of the Connecticut General Statutes, the entire amount of foreign income taxes paid or accrued to arrive at its net income for Connecticut Corporation Business Tax purposes for the years in question, despite the fact that the plaintiff elected under [s] 901 of the Internal Revenue Code to treat such foreign income taxes as a credit, rather than as a deduction, for federal income tax purposes, and was thus precluded from taking a 'deduction' of such foreign taxes on the plaintiff's federal income tax returns for the years in question under [ss] 275(a)(4) and 905(a) of the Internal Revenue Code?" 7

Resolution of the question reserved to us requires an examination of relevant provisions of the statutes governing the corporate business tax. By way of background, General Statutes § 12-213 defines "gross income" as "gross income as defined in the federal corporation net income tax law ..." and "net income" as "net earnings received during the income year and available for contributors of capital, whether they are creditors or stockholders, computed by subtracting from gross income the deductions allowed by the terms of section 12-217...." The key provision, however, is General Statutes § 12-217(a) which states that "[i]n arriving at net income as defined in section 12-213, whether or not the taxpayer is taxable under the federal corporation net income tax, there shall be deducted from gross income, (A) all items deductible under the federal corporation net income tax law effective and in force on the last day of the income year...."

The parties offer competing versions of the meaning to be attributed to § 12-217's reference to "items deductible under the federal corporation net income tax law." The plaintiff argues that the statute allows a taxpayer to deduct all items that could have been deducted under the federal tax law, not just those items that were in fact deducted on the taxpayer's federal tax return. Since the plaintiff was permitted to treat foreign income taxes as a deduction from gross income by 26 U.S.C. § 164(a)(3), 8 the plaintiff argues that these taxes were deductible despite its election to take federal tax credits rather than federal tax deductions in the relevant tax years. The defendant maintains, to the contrary, that once foreign taxes have been claimed as tax credits, they are no longer deductible under the federal tax law; 26 U.S.C. §§ 275(a)(4) and 905(a), and therefore that they are not deductible under § 12-217. In effect, the issue is whether § 12-217 makes the plaintiff's federal election binding on the plaintiff's calculation of its state tax obligation. Although the question is a close one, we agree with the defendant that it does.

While we have not previously addressed the implications of a taxpayer's federal election on his privilege to claim deductions under our state tax laws, we do not write on a clean slate. We have repeatedly recognized that our tax laws incorporate federal tax principles; Harper v. Tax Commissioner, 199 Conn. 133, 506 A.2d 93 (1986); The B.F. Goodrich Co. v. Dubno, 196 Conn. 1, 7, 490 A.2d 991 (1985); Yaeger v. Dubno, 188 Conn. 206, 210, 211-12, 449 A.2d 144 (1982); Woodruff v. Tax Commissioner, 185 Conn. 186, 191, 440 A.2d 854 (1981); Peterson v. Sullivan, 163 Conn. 520, 525, 313 A.2d 49 (1972); Kellems v. Brown, 163 Conn. 478, 518-19, 313 A.2d 53 (1972), appeal dismissed, 409 U.S. 1099, 93 S.Ct. 911, 34 L.Ed.2d 678 (1973); First Federal Savings & Loan Assn. v. Connelly, 142 Conn. 483, 489-93, 115 A.2d 455 (1955), appeal dismissed, 350 U.S. 927, 76 S.Ct. 305, 100 L.Ed. 811 (1956); McKesson & Robbins, Inc. v. Walsh, 130 Conn. 460, 461-64, 35 A.2d 865 (1944). It is therefore highly significant that the federal tax code, in 26 U.S.C. §§ 275(a)(4) and 905(a), prohibits a taxpayer who has taken a tax credit from thereafter claiming a tax deduction for the payment of foreign taxes. We have previously held taxpayers to the state law consequences of their federal tax elections. Harper v. Tax Commissioner, supra; Miller v. Heffernan, 173 Conn. 506, 519, 378 A.2d 572 [199 Conn. 352] (1977), appeal dismissed, 434 U.S. 1057, 98 S.Ct. 1226, 55 L.Ed.2d 758 (1978). Furthermore, we have uniformly adhered to the view that deductions from otherwise taxable income are a matter of legislative grace and hence are strictly construed against the taxpayer. Harper v. Tax Commissioner, supra; The B.F. Goodrich Co. v. Dubno, supra, 196 Conn. at 8-9, 490 A.2d 991; Yaeger v. Dubno, supra, 188 Conn. at 212, 449 A.2d 144. Finally, we have frequently expressed our deference to legislative choices about the equities of classifications in tax statutes. As has the Supreme Court of the United States, we have acknowledged "the large area of discretion which is needed by a legislature in formulating sound tax policies.... [I]n taxation, even more than in other fields, legislatures possess the greatest freedom in classification." Kellems v. Brown, supra, 163 Conn. at 487, 313 A.2d 53, quoting Madden v. Kentucky, 309 U.S. 83, 87-88, 60 S.Ct. 406, 407-08, 84 L.Ed. 590 (1940); Gunther v. Dubno, 195 Conn. 284, 291, 487 A.2d 1080 (1985); Miller v. Heffernan, supra, 173 Conn. at 509-10, 378 A.2d 572. In combination, these precedents lend strong support to the position of the defendant tax commissioner in this case.

In order to prevail in the light of these precedents, the plaintiff must establish that § 12-217 clearly and unambiguously authorizes a corporate taxpayer's right to claim a deduction for foreign taxes despite the taxpayer's exercise of his federal right to treat such taxes as a credit. The plaintiff asks us to focus on two aspects of the text of § 12-217(a): (1) the use of the adjective "deductible" rather than "deducted" as a criterion of an allowable deduction; and (2) the use of the referent "gross income" to define the base from which items "shall be deducted." Because the dictionary definition of "deductible" is "capable of being deducted"; Webster, Third New International Dictionary; and because the legislature chose a referent other than the taxpayer's federal taxable income, the plaintiff maintains that items that could have been deducted from the plaintiff's federal gross income are equally deductible under § 12-217.

As the defendant points out, however, the plaintiff's analysis does not take full account of all of the relevant text of § 12-217(a). In describing the items that are deductible, the statute refers to "the taxpayer" and to "deductible under the federal corporation net income tax law effective and in force on the last day of the income year...." This language supports the defendant's construction of "d...

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    ...income are a matter of legislative grace and hence are strictly construed against the taxpayer.... Skaarup Shipping Corporation v. Commissioner, 199 Conn. 346, 352, 507 A.2d 988 (1986); Golf Digest/Tennis, Inc. v. Dubno, 203 Conn. 455, 464, 525 A.2d 106 (1987). Thus, in order for the taxpay......
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