Unisys Corp. v. Com.

• Decision Date: 08 March 1999
• Citation: Unisys Corp. v. Com., 726 A.2d 1096 (Pa. Commw. Ct. 1999)
• Parties: UNISYS CORPORATION, Petitioner, v. COMMONWEALTH of Pennsylvania, Respondent (Three Cases).
• Court: Pennsylvania Commonwealth Court

726 A.2d 1096

UNISYS CORPORATION, Petitioner, v. COMMONWEALTH of Pennsylvania, Respondent (Three Cases).

Commonwealth Court of Pennsylvania.

Argued May 6, 1998.

Decided March 8, 1999.

As Amended March 12, 1999.

Joseph C. Bright, Philadelphia, for petitioner.

Kevin A. Moury, Senior Deputy Atty. Gen., Harrisburg, for respondent.

Before COLINS, President Judge, DOYLE, J., SMITH, J., PELLEGRINI, J., FRIEDMAN, J., FLAHERTY, J., and LEADBETTER, J LEADBETTER, Judge.

Unisys Corporation petitions for review of three orders of the Board of Finance and Revenue (Board) which affirmed the Department of Revenue's (Department) settlement of Unisys' 1986 franchise tax and Sperry Corporation's¹ 1985 and 1986 franchise tax. The Pennsylvania franchise tax, which is imposed on the capital stock value of every out of state corporation that does business within Pennsylvania, is designed to tax business activity conducted within the Commonwealth only. Section 602(b) of the Tax Reform Code of 1971 (Tax Code), Act of March 4, 1971, P.L. 6, as amended, 72 P.S. § 7602(b). In calculating the franchise tax, the reporting corporation must first calculate its capital stock value ["actual value"] by a statutory formula based upon the corporation's net worth,² which includes the net worth of any entity in which the corporation owns common stock, and the corporation's average net income, which includes dividends received from investee corporations.³ Section 601(a) of the Tax Code, 72 P.S. § 7601(a); 61 Pa.Code §§ 155.26, 155.27. After determining the capital stock value, the corporation must arrive at taxable value, 72 P.S. § 7602(b), by applying an apportionment factor to the actual value.

Since a state may not constitutionally tax value earned outside its borders, the Tax Code sets forth two methods by which a corporation may apportion the value of its capital stock attributable to business activities within and without the Commonwealth, namely, the single-factor method⁴ and the three-factor method. The choice of method is left to the taxpayer.⁵

The three-factor apportionment formula averages three fractions—property, payroll and sales—to determine the taxable portion of a foreign corporation's capital stock value:

Property in PA + Payroll in PA + Sales in PA ___________________ __________________ ________________ Property everywhere Payroll everywhere Sales everywhere ÷ 3 = Apportionment factor (Actual value) X (Apportionment factor) X (10 mills) = Tax due

72 P.S. § 7602(b)(1). As consistently interpreted and applied by the Department, the property, payroll and sales figures that comprise the three fractions represent only the property, payroll and sales of the taxpayer itself, and not of the taxpayer's subsidiaries. Thus, under this method, while the net worth of and dividends paid by certain subsidiaries of a corporation are included in the corporation's actual value, the property, payroll and sales of those subsidiaries are not considered in the apportionment formula.

Unisys, a Delaware corporation with its principal office in Blue Bell, Pennsylvania, does business in all states of the United States. During the tax years at issue, Unisys owned, directly or indirectly, the stock of more than 100 domestic and foreign subsidiaries doing business in more than 100 countries around the world. In the franchise tax returns at issue, Unisys reported its average net income on a separate company, unconsolidated basis and did not include as income dividends it received from subsidiaries or other investee corporations. Unisys likewise reported its net worth on a separate company, unconsolidated basis and elected to apportion its capital stock value using the three-factor formula, rather than the single-factor asset apportionment fraction. In settling Unisys' franchise tax for the applicable years, the Department increased the amount reported by Unisys as net worth to include the value of Unisys' investments in its subsidiaries and increased the amount reported as average net income by adding the amount of dividends paid to Unisys by its subsidiaries and investee corporations. The Department calculated Unisys' property, payroll and sales apportionment factors on a separate company basis, that is, the factors included only the property, payroll and sales of Unisys itself and not the property, payroll and sales of its subsidiaries. Unisys appealed the Department's settlements, requesting refunds. The Board affirmed the Department's settlements and denied Unisys' refund requests. This appeal followed.⁶ The question presented is whether the interstate commerce and due process clauses of the United States Constitution require the Commonwealth to include property, payroll and sales of subsidiaries in the three-factor apportionment formula and, if not, whether the Pennsylvania statutory scheme mandates administrative relief.⁷

The commerce clause prohibits a state from taxing value earned outside its borders. Where the value attributable to a particular location is not capable of precise definition, the state's method of determining its share of total value is tested by the requirements of due process. Thus, although the requirements of the commerce clause and due process are distinct—the former imposing a substantive limitation upon the state's power to tax and the latter regulating the procedures by which the states may comply with that substantive law—they are closely interrelated. As a practical matter, if the method used to apportion total income between in state (taxable) and out of state (non-taxable) components is fair, the substantive requirements of the commerce clause will ordinarily be met. Hence, most cases analyze these separate constitutional requirements jointly, focusing primarily on the due process issue. As the court noted in Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 103 S.Ct. 2933, 77 L.Ed.2d 545 (1983), the interstate commerce clause "has not in practice required much in addition to the requirement of fair apportionment." Id. at 171, 103 S.Ct. 2933.

In the case of a multi-state or multinational company, the Supreme Court has noted that "arriving at precise territorial allocations of value is often an elusive goal." Id. at 164, 103 S.Ct. 2933. As a result, states must often resort to the use of formulas based upon more readily ascertainable measures of the corporation's activities within and without the state in order to apportion the taxes. The rationale which provides the constitutional predicate for such apportionment is the notion of the "unitary business enterprise," i.e., an enterprise which carries out distinct multijurisdictional activities resulting in ultimate profit or value derived from the entire business operation. As the court noted in Container:

The unitary business formula apportionment method rejects geographical or transactional accounting, and instead calculates the local tax base by first defining the scope of the "unitary business" of which the taxed enterprise's activities in the taxing jurisdiction form one ... party, and then apportioning the total income of that "unitary business" between the taxing jurisdiction and the rest of the world on the basis of a formula taking into account objective measures of the corporation's activities within and without the jurisdiction.

Id. at 165, 103 S.Ct. 2933. Further, "[t]he functional meaning of [the unitary business enterprise] requirement is that there be some sharing or exchange of value not capable of precise identification or measurement... which renders formula apportionment a reasonable method of taxation." Id. at 166, 103 S.Ct. 2933. In Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425, 100 S.Ct. 1223, 63 L.Ed.2d 510 (1980), the court made clear that this is a functional concept which disregards corporate formalities:

So long as dividends from subsidiaries and affiliates reflect profits derived from a functionally integrated enterprise, those dividends are income to the parent earned in a unitary business.

Id. at 440, 100 S.Ct. 1223.

In addition to the requirement that the business must be a unitary enterprise before its total profit or value is subject to tax based upon an apportionment formula, the due process clause also requires that any such formula be fair. Initially, we note that the Supreme Court has repeatedly upheld the constitutionality of the three-factor apportionment formula. "Indeed," the court noted in Container, "not only has the three-factor formula met our approval, but it has become ... something of a benchmark against which other apportionment formulas are judged." 463 U.S. at 170, 103 S.Ct. 2933. Unisys' challenge, however, lies not with the formula itself, but with the Department's use in the formula of payroll, property, and sales data of only the parent corporation. The essence of Unisys' argument on appeal is that it is fundamentally unfair for the Department to include as income the dividends Unisys received from its subsidiaries and as net worth the value of its investments in the subsidiaries when calculating the actual value of the corporation, but not include its subsidiaries' property, payroll and sales in the apportionment formula.

Since the purpose of the formula is to apportion the value of the unitary business enterprise among different jurisdictions, it can hardly be subject to dispute that an apportionment formula which includes data from the entire enterprise will yield a more accurate result than a formula based solely upon the parent corporation's operations. That is not the question before this court, however, but rather whether this approach is constitutionally mandated. Although never addressed by the full court,⁸ an affirmative answer was urged by Justice Stevens in his dissent in Mobil Oil Corp.:

Either Mobil's worldwide "petroleum enterprise,"... is all part of one unitary business, or it is not; if it is, Vermont must evaluate the entire enterprise in a

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