State, Dept. of Revenue v. OSG Bulk Ships, Inc.

• Decision Date: 20 February 1998
• Docket Number: No. S-7498,S-7498
• Citation: 961 P.2d 399
• Parties: STATE of Alaska, DEPARTMENT OF REVENUE, Appellant, v. OSG BULK SHIPS, INC., Appellee.
• Court: Alaska Supreme Court

Page 399

961 P.2d 399

STATE of Alaska, DEPARTMENT OF REVENUE, Appellant, v. OSG BULK SHIPS, INC., Appellee.

No. S-7498.

Supreme Court of Alaska.

Feb. 20, 1998.

Rehearing Denied Aug. 18, 1998.

Stephen C. Slotnick, Assistant Attorney General, and Bruce M. Botelho, Attorney General, Juneau, for Appellant.

Ann M. Bruner, Brian W. Durrell, Bogle & Gates, Anchorage, and D. Michael Young, Bogle & Gates, Bellevue, Washington, and Walter Hellerstein, University of Georgia, Atlanta, Georgia, for Appellee.

Susan A. Burke and Avrum M. Gross, Gross & Burke, Juneau, for Amicus Curiae Alaska Visitors Association.

Kenneth Klein, Cadwalader, Wickersham & Taft, Washington, D.C., and Ronald L. Baird, Anchorage, for Amicus Curiae North West CruiseShip Association.

Before RABINOWITZ, MATTHEWS, EASTAUGH and FABE, JJ.

OPINION

EASTAUGH, Justice.

I. INTRODUCTION

This appeal raises questions about the tax payable under the Alaska Net Income Tax Act, AS 43.20.011-43.20.350 (ANITA), for tax years 1981 through 1988 on income derived by the taxpayer from domestic and foreign shipping operations and investments. The State of Alaska, Department of Revenue (DOR) assessed additional income taxes against the taxpayer, OSG Bulk Ships, Inc. The superior court reversed DOR's decision and DOR now appeals. We now reverse in part and remand for further proceedings.

II. FACTS AND PROCEEDINGS

A. Facts

OSG Bulk Ships, Inc. (OBS), a New York corporation, is a wholly-owned first-tier subsidiary of Overseas Shipholding Group, Inc. (OSG), a Delaware corporation. OBS and OSG both have their commercial domiciles in New York. OSG has more than a fifty percent ownership interest in over one hundred subsidiaries and partnerships, most of which are shipping companies. The shipping companies collectively own approximately sixty-five ocean-going vessels used in different types of trade throughout the world. OBS owns all of the domestic shipping companies; OSG International, Inc., which is also a first-tier subsidiary of OSG, owns most of the foreign shipping companies.

OSG, including its subsidiaries, is engaged in the ocean transportation of liquid and dry bulk cargoes in both the worldwide and U.S. domestic markets. It owns the largest independent fleet of unsubsidized U.S.-flag tankers, and is a major participant in the Alaskan oil trade. The rest of OSG's fleet is registered under foreign flags. OSG also owns several other companies, including holding companies, financial companies, service companies, and an insurance company.

OBS is the taxpayer. It owned corporations that in turn owned or chartered tanker vessels entering Alaska waters during audit years 1981 to 1988. ¹ OBS and its domestic shipping companies reported their Alaska taxes on a unitary basis (as if they were a single taxpayer engaging in a single business). OBS did not include in the unitary group the foreign corporations related by ownership to OSG. Nor did OBS include the investment subsidiaries because OBS claimed they had no connection with Alaska and were not part of OBS's unitary business. OBS also claimed investment tax credits for new vessels.

B. Proceedings

Following audits by DOR's Income and Excise Audit Division (Audit Division), DOR assessed OBS additional income taxes for tax years 1979 through 1983, 1985 through 1986, and 1988.

The Audit Division included approximately ninety foreign corporations in OBS's unitary group, determining that "OSG and all its more-than-50-percent-owned subsidiaries, including OBS, were engaged in a single, unitary business during the period under audit." This had the effect of including in the "worldwide unitary income" of OBS's corporate group the income of the foreign corporations and all of the subsidiaries in which OSG had more than fifty percent ownership. The taxable corporate income attributable to the group's Alaska business was then calculated by multiplying the worldwide unitary income of the entire group by an "apportionment fraction" derived by dividing the value of the group's Alaska business activities by the value of its worldwide business activities. See AS 43.19.010 art. IV, p 9. This adjustment increased OBS's income taxable in Alaska, and the Audit Division assessed additional taxes. ²

OBS protested the assessments. Following administrative proceedings, DOR's hearing officer issued a recommended decision which DOR's Commissioner adopted. In pertinent part, the decision held that (1) income earned by OBS's foreign subsidiaries from operation of foreign flag vessels was not exempted by 26 U.S.C. § 883 and was therefore includable in OBS's apportionable income; (2) DOR did not exceed its statutory authority by promulgating 15 AAC 20.110(d), a regulation that reduced OBS's investment tax credit; and (3) OBS's investment income was properly treated as business income for Alaska tax purposes. As of July 1993 OBS's tax assessments totaled $789,495.

OBS appealed to the superior court, which reversed each of these three rulings.

DOR now appeals the superior court's rulings on these three issues.

III. DISCUSSION

A. Whether Internal Revenue Code Section 883 Exempts OBS's Foreign Shipping Income from Taxation by Alaska

The Alaska Net Income Tax Act (ANITA), AS 43.20.011-43.20.350, taxes a corporation's "entire taxable income ... derived from sources within the state." AS 43.20.011(e). When OBS filed its 1981-88 Alaska tax returns, it excluded from its tax base all income derived from vessels owned by the foreign subsidiaries in its unitary group. In doing so, OBS reasoned that AS 43.20.021(a) had incorporated subsection 883(a)(1) ³ of the federal Internal Revenue Code (IRC), codified at 26 U.S.C. § 883(a)(1), into ANITA, and that section 883 exempted foreign shipping income.

Alaska Statute 43.20.021(a) incorporates sections of the IRC into the ANITA and the Multistate Tax Compact (MTC), AS 43.19.010-43.19.050, ⁴ unless the IRC provisions are "excepted to or modified by" other ANITA provisions. ⁵ The sections adopted by reference encompass IRC section 883.

DOR disallowed the exemption, finding that OBS had not proven that its foreign shipping income was exempt from OBS's apportionable tax base. Reversing, the superior court held that AS 43.20.021(a) had incorporated subsection 883(a)(1) into Alaska law, thus exempting OBS's foreign shipping income.

DOR contends on appeal that subsection 883(a)(1) is "excepted to or modified by" the ANITA, given differences in the methods employed by the State of Alaska and by the federal government for determining taxable income. ⁶ OBS argues that Alaska's income tax scheme is "entirely consistent" with the section 883 exemption. ⁷

This is not the first time we have considered whether Internal Revenue Code provisions, ostensibly adopted by reference by AS 43.20.021(a), were "excepted to or modified by" other ANITA provisions. In Gulf Oil Corp. v. State, Department of Revenue, 755 P.2d 372, 380 (Alaska 1988), we held that a portion of the IRC dealing with the foreign tax credit was "excepted to or modified by" AS 43.20, which allowed neither a deduction nor a credit for foreign income taxes. In so holding, we noted that "[t]hat is not to say that Alaska law incorporates no Code provisions and no federal regulations having to do with the foreign tax credit. Future cases may reveal that it is desirable to conform our law to certain aspects of those federal provisions." Id. The source of the exception in Gulf Oil was the absence in AS 43.20 of any provision for a deduction similar to that provided by the IRC.

In this case, we must decide whether the tax scheme employed by the ANITA implicitly excepts to or modifies application of section 883. We first compare the different methodologies applied by the United States and the State of Alaska to determine taxable income.

When a state seeks to tax the income of a multinational business, it must determine the income properly allocable to in-state activities. Id. at 374. At all relevant times, Alaska has employed the worldwide formula apportionment method to calculate a multinational or interstate corporation's income earned in Alaska. AS 43.20.065; AS 43.19.010, art. IV, p 9. Under that method, in-state income is determined by multiplying a corporation's worldwide income by an "apportionment fraction." AS 43.19.010, art. IV, p 9. ⁸ A taxpayer's apportionment fraction is the numerical average of three factors-- its "property factor," its "payroll factor," and its "sales factor"--which compare its in-state business activities with its worldwide business activities. ⁹

The United States does not utilize the "formula apportionment" method when it calculates the federal taxable income of multinational corporations. Instead, it uses "sourcing" provisions to allocate income to the United States or to other sources, depending upon where the income is earned. 26 U.S.C. §§ 861-65; see also 26 C.F.R. § 1.861-1 (1996). Income that cannot reasonably be "sourced" to the United States is deducted from the taxpayer's gross income and is not included when a taxpayer's U.S. income is calculated. Id.

There is consequently a fundamental difference in the way these governments calculate the taxable income of a multinational corporation. Alaska accomplishes its calculation by applying to all income an apportionment fraction that separates the local income from that earned elsewhere. The key to proper separation under this method is the apportionment fraction; it is in the calculation and application of this fraction that the separation is made. In comparison, the United States makes this separation when it first allocates income to sources inside and outside the United States.

OBS and DOR agree that Alaska's adoption of the worldwide apportionment method in AS 43.19 establishes an exception to IRC sections 861 through 865, which relate to the "sourcing" of income for tax purposes. They disagree, however, about whether IRC section 883, which is contained in...