SLI Intern. Corp. v. Crystal

• Decision Date: 27 February 1996
• Docket Number: No. 15160,15160
• Citation: 671 A.2d 813,236 Conn. 156
• Court: Connecticut Supreme Court
• Parties: SLI INTERNATIONAL CORPORATION v. Allan A. CRYSTAL, Commissioner of Revenue Services.

Page 813

671 A.2d 813

236 Conn. 156

SLI INTERNATIONAL CORPORATION v. Allan A. CRYSTAL, Commissioner of Revenue Services.

No. 15160.

Supreme Court of Connecticut.

Argued Dec. 7, 1995.

Decided Feb. 27, 1996.

Charles L. Howard, with whom were Charles B. Milliken and Sheila A. Huddleston, Hartford, for appellant (plaintiff).

Paul M. Scimonelli, Assistant Attorney General, with whom, on the brief, was Richard Blumenthal, Attorney General, for appellee (defendant).

Before CALLAHAN, BORDEN, BERDON, KATZ and PALMER, JJ.

KATZ, Associate Justice.

The dispositive issue on appeal is whether the trial court's determinations that the plaintiff, SLI International Corporation, had failed to comply with General Statutes § 12-217(a)(D)(1) by deducting expenses related to dividends and that the defendant, the commissioner of revenue services (commissioner), had properly adjusted the plaintiff's calculation of net income pursuant to General Statutes § 12-226a by disallowing those deductions for commission expenses because such deductions resulted in an improper or inaccurate reflection of the plaintiff's income are legally and logically correct. We conclude that they are not and, accordingly, reverse the judgment of the trial court to the contrary.

The parties have stipulated to the following facts. The plaintiff, a Delaware corporation with its principal place of business in Stamford, manufactures, markets and distributes aerospace equipment in an international market. It is a wholly owned subsidiary of Smiths Industries, Inc. (Smiths), a Florida corporation, which is not authorized to do business in Connecticut. Smiths Industries International Sales Corporation (Smiths International), also a wholly owned subsidiary of Smiths, is a corporation properly organized under the laws of the United States Virgin Islands and qualifies as a foreign sales corporation (FSC) under 26 U.S.C. § 922(a) (1994). ¹ A FSC is, in essence, "a legal entity through which a parent corporation may channel export sales and receive a tax benefit under circumstances in which the export sales would otherwise generate profits taxable at normal rates." ² P. Day, "Foreign Sales Corporations: Connecticut Tax Implications," 60 Conn.B.J. 307, 310 (1986).

In September, 1987, the plaintiff entered into a sales representative and commission agreement with Smiths International for the purpose of selling the plaintiff's products in an international market. ³ Smiths International agreed to perform or to contract for the performance of all activities necessary for the sale of the plaintiff's products as required by 26 U.S.C. § 925(c) (1994), ⁴ including marketing and sales promotion, processing customers' orders, and billing. At the end of fiscal years 1988 and 1989, the plaintiff compensated Smiths International for its sales activities by paying to Smiths International commissions properly due pursuant to 26 U.S.C. § 925(a) (1994). ⁵ Thereafter, for purposes of its Connecticut corporation business tax for those two years, the plaintiff deducted the commission expenses pursuant to General Statutes § 12-217(a)(A). ⁶ Furthermore, Smiths International declared and paid dividends to Smiths in an amount equal to the commissions Smiths International had received from the plaintiff. The commissions were the sole source of funds for those dividends.

Following an audit of the plaintiff for the fiscal years 1988 and 1989, the commissioner, by invoking his discretion under General Statutes § 12-226a ⁷ to adjust income where it has been "improperly or inaccurately reflected," disallowed 8/23 of the commission expense deduction for each of the two years. ⁸ Although the commissioner recognized that Smiths International was properly created and formed under federal law as a valid FSC, he nevertheless considered it to be valid on paper only because it had no economic substance. By determining that it had no economic reality, he felt justified in disregarding its existence in the arrangement between the plaintiff and Smiths. In eliminating Smiths International, the commissioner viewed the transaction as one strictly between the plaintiff and Smiths in which the plaintiff paid commissions directly to Smiths and, in return, Smiths paid dividends to the plaintiff. Accordingly, the commissioner considered the commission expenses incurred by the plaintiff to be directly related to the dividends. Because "expenses related to dividends" are not deductible under § 12-217(a)(D), ⁹ the commissioner disallowed the deductions.

The plaintiff appealed from the commissioner's decision to the trial court, Aronson, J., which dismissed the appeal. ¹⁰ The trial court based its judgment on two theories. First, it found that § 12-217(a)(D)(1) alone authorized the commissioner's decision to disallow the commission expense deductions. The trial court, in essence, reasoned that the plaintiff had violated that provision by deducting expenses related to dividends. The court also affirmed the commissioner's decision to invoke his discretionary powers under § 12-226a, and agreed with the commissioner that although Smiths International had been properly formed as a sanctioned FSC, it was in essence a paper corporation that had no economic substance. The court concluded, therefore, that the commissioner had properly invoked his authority under § 12-226a to reorganize the transaction as one solely between the plaintiff and Smiths and, consequently, to adjust the plaintiff's income. Thereafter, the plaintiff appealed from the judgment of the trial court to the Appellate Court, and we transferred the appeal to this court pursuant to Practice Book § 4023 and General Statutes § 51-199(c).

"The scope of our appellate review depends upon the proper characterization of the rulings made by the trial court. To the extent that the trial court has made findings of fact, our review is limited to deciding whether such findings were clearly erroneous. When, however, the trial court draws conclusions of law, our review is plenary and we must decide whether its conclusions are legally and logically correct and find support in the facts that appear in the record. Practice Book § 4061; United Illuminating Co. v. Groppo, 220 Conn. 749, 752, 601 A.2d 1005 (1992); Zachs v. Groppo, 207 Conn. 683, 689, 542 A.2d 1145 (1988); Pandolphe's Auto Parts, Inc. v. Manchester, 181 Conn. 217, 221-22, 435 A.2d 24 (1980).

"In this case, the trial court's determinations were based on a record that consisted solely of a stipulation of facts, written briefs, and oral arguments by counsel. The trial court had no occasion to evaluate the credibility of witnesses or to assess the intent of the parties in light of additional evidence first presented at trial. The record before the trial court was, therefore, identical with the record before this court. In these circumstances, the legal inferences properly to be drawn from the parties' definitive stipulation of facts raise questions of law rather than of fact. Cf. Connecticut National Bank v. Douglas, 221 Conn. 530, 545, 606 A.2d 684 (1992); Bell Food Services, Inc. v. Sherbacow, 217 Conn. 476, 482 n. 7, 586 A.2d 1157 (1991); Canaan National Bank v. Peters, 217 Conn. 330, 335, 586 A.2d 562 (1991); Mizla v. Depalo, 183 Conn. 59, 63 n. 8, 438 A.2d 820 (1981). Accordingly, our review of the ruling of the trial court in this case is plenary." Morton Buildings, Inc. v. Bannon, 222 Conn. 49, 53-54, 607 A.2d 424 (1992). Because we conclude that the inferences the trial court drew from the stipulation of facts are legally and logically incorrect, we reverse.

We begin our discussion with the interrelationship among § 12-217(a)(A), which permits a taxpayer to take a deduction that is allowable under the federal corporation income tax laws; D.A. Pincus & Co. v. Meehan, 235 Conn. 865, 871-72, 670 A.2d 1278 (1996); § 12-217(a)(D)(1), which provides that a taxpayer may not, however, deduct "expenses related to dividends" from gross income; Bolt Technology Corp. v. Commissioner of Revenue Services, 213 Conn. 220, 226-30, 567 A.2d 371 (1989); and § 12-226a, which permits the commissioner to adjust income where it has been improperly or inaccurately reflected. Section 12-226a grants the commissioner broad discretion to adjust computations of income whenever he finds that the taxpayer's determination of income is improper or inaccurate. We agree with the commissioner that such impropriety or inaccuracy need not be an intentional misrepresentation of income, but can instead be a mere inaccuracy of income as compared to what the commissioner deems in his discretion to be a proper reflection of the taxpayer's income.

Section 12-226a is virtually identical to the adjustment provision in New York Tax Law § 211(5) (McKinney 1986). ¹¹ "The fact that a statute is almost a literal copy of a statute of a sister state is persuasive evidence of a practical reenactment of the statute of the sister state; as such it is proper to resort to the decisions of a sister court construing that statutory language." State v. Elliott, 177 Conn. 1, 5, 411 A.2d 3 (1979). The New York Court of Appeals has interpreted § 211(5) to give the tax commission wide discretion to determine whether income has been improperly or inaccurately reflected and will uphold the commission's decision if it has a rational basis. See, e.g., Campbell Sales Co. v. New York State Tax Commission, 68 N.Y.2d 617, 619-20, 496 N.E.2d 213, 505 N.Y.S.2d 54 (1986), cert. denied, 479 U.S. 1088, 107 S.Ct. 1295, 94 L.Ed.2d 151 (1987) (commission's decision upheld unless it is abuse of discretion). We also note that the federal tax laws contain a provision, 26 U.S.C. § 482 (1994), ¹² that has the same spirit as § 12-226a, yet is more restrictive in that its language is less discretionary. Nevertheless, it has been interpreted to grant to the United States Secretary of the Treasury broad discretion to allocate income and deductions between related corporations...