F. W. WOOLWORTH CO. v. TAXATION & REVENUE DEPT.
Legal provision: Due Process
ORAL ARGUMENT OF WILLIAM L. GOLDMAN, ESQ., ON BEHALF OF THE APPELLANT
Chief Justice Burger: We will hear arguments next in F. W. Woolworth against the State of New Mexico.
Mr. Goldman, I think you may proceed.
Mr. Goldman: Mr. Chief Justice, and may it please the Court, this state income tax case involves the same basic constitutional issues that you discussed this morning and this afternoon in the ASARCO case.
Woolworth, the Appellant in this case, is a New York corporation engaged in the retail business throughout the United States, Puerto Rico, and the Virgin Islands.
It purchases consumer items that it sells at retail through its Woolworth and Woolco stores.
Woolworth also owns four major foreign subsidiaries that are engaged in the same general type of business in Germany, the United Kingdom, Canada, and Mexico.
The dispositive issue here is whether the retail businesses of the foreign subsidiaries are functionally integrated with Woolworth's domestic retail business in the United States.
If the foreign operations are functionally integrated, then we agree that the dividends paid by the foreign subsidiaries are properly includable in apportionable income.
That was the question decided by this Court in Mobil, and the reason would be that where you have an admittedly unitary business, as this Court recognized in Underwood Typewriter, it is impossible to allocate specifically the portion of the profits of that business that were earned in any particular jurisdiction where the business was conducted.
And so formulary apportionment is appropriate, and for that purpose, where the unitary business includes the operations of the subsidiaries, the dividends can be treated as part of the apportionable income.
Of course, if the business were defined as including the operations of the subsidiaries, so the dividends are included in the apportionable base, then that would necessitate the payroll, property, and sales of the subsidiaries be correlatively reflected in the apportionment--
Unidentified Justice: Well, in that case it wouldn't be just the dividends.
It would be the income of the subs.
Mr. Goldman: --Your Honor, if the state were seeking to have combined reporting, we might be concerned about the treatment of the underlying operating income.
Unidentified Justice: Well, is your position then, if they are going to take the dividends into account, they must take into account all of the property and payroll?
Mr. Goldman: No, Your Honor.
The answer is essentially the same as was made this morning.
Unidentified Justice: All right.
Mr. Goldman: Where the dividends paid reflect a percentage of the profits earned by the subsidiary, then you should reflect a commensurate percentage of the underlying payroll, property, and sales that are fairly related to the portion of the profits being distributed.
On the other hand, where the operations of the subsidiary are not functionally related to the business being conducted in the United States, the dividends should not be included in apportionable income.
The dividends have no role to play in the state tax calculation, because they represent income earned in the course of totally unrelated activities.
Unidentified Justice: I get a feeling you are using the term "functionally related" in not quite the same way as your friends on the preceding case.
Mr. Goldman: By functionally related, I am referring to the operational activities conducted by the subsidiaries in their respective countries.
Unidentified Justice: All of your business is retail sales, is it not, domestic and foreign?
Mr. Goldman: --That's correct.
Unidentified Justice: And that distinguishes it in some respects from the prior case, does it not?
Mr. Goldman: Well, it distinguishes this case from some of the subsidiaries that pay dividends to ASARCO.
There was discussion this morning of MIM, which is engaged in a comparable line of business as the parent corporation.
Unidentified Justice: And with asbestos, which they said was a different--
Mr. Goldman: That's correct.
The state made a distinction between the cases where the subsidiary was engaged in the same or similar line of business and an unrelated line of business.
Our point is that it should make absolutely no difference at all where the operations of the businesses are functionally separate and unrelated.
The question here is to determine how much of Woolworth's income is fairly attributable to its operations in New Mexico.
That is all New Mexico can tax, and if income is earned in the course of separate activities, albeit the same type of business, but functionally separate, so that income is earned by a self-contained, free-standing business operating in Europe, then New Mexico has no claim to tax any part of that income.
It can only claim a share of the income earned from the business a portion of which is conducted in New Mexico.
The key question as to whether the income from the foreign subsidiaries should be taken into account, the key issue is whether the businesses are related, functionally related, not whether it is the same kind of business.
Unidentified Justice: --Do you think our cases lay down any test for when a business is or is not functionally related to another one?
Mr. Goldman: Oh, absolutely.
I think through all of the decisions of this Court, starting with Adams Express, and Underwood, Bass, Ratcliff, I think in every instance where this Court has found a unitary business, there has been a degree of functional relationship between the operations of the business that is totally missing in this case.
Unidentified Justice: Well, it may be possible to go back through the facts of each of the cases and say that all of them conform to one pattern, but do you rely upon any one case for a definition of your term "functionally integrated"?
Mr. Goldman: --Not as such, Your Honor.
I think what the cases say is, where the business earns its profits as a whole as an economic unit, then you have a unitary business.
There is a phrase, "as a unit", "operating as a unit", in the Adams Express case, for example, and in that opinion the Court goes on to say that unity of ownership is insufficient, because you can have two separate businesses with the same ownership, and as long as they operate separately, then they have no relationship to each other, but I don't... I can't point to a sentence as such which defines a unitary business, but I think it is easy to read all of the opinions and come away with the absolute conviction that in order to have a unitary business, there must be a functional relationship.
What this Court said... one guide may be in the Mobil opinion.
The Court said that in order to show that the dividends are not apportionable, you must show that they were earned in the course of activities unrelated to the business conducted in the taxing state.
The income must be earned in the course of activities unrelated to the business conducted in the taxing state.
All of the income earned by Woolworth's subsidiaries is earned in the course of activities unrelated to the conduct of the domestic retail business.
Unidentified Justice: Are we to infer from that that the source of supply for the European outlets is all in the European market?
Mr. Goldman: The record is very clear.
Let me get to the facts, Your Honor.
The record is very clear that each corporation conducted its inventory purchasing on a separate basis.
To a large extent, each subsidiary purchased its inventory in its own country, but the facts show that even where they purchased in the same countries, in the Orient, for example, each one purchased separately from the others and on its own, and indeed there is a suggestion that they may to a certain extent almost have been competitive with each other, but certainly there was no coordinated central purchasing function at all.
Let's look at the facts in the case.
The record shows that each subsidiary independently carried on all of the essential operations of a retail business.
These include selecting site for stores, determining the type and quantity of merchandise to carry, purchasing the inventory, advertising, funding of operations, accounting and cash control, personnel selection and training.
All of the essential functions were carried on separately by each subsidiary.
Each subsidiary was a self-contained economic unit.
I think the facts in this case stand in sharp contrast, as I said before, to all of the prior decisions of this Court in which a functionally integrated unitary business has been found to be present.
The case that perhaps provides the clearest guidance here is Butler Brothers v. McColgan, since it also involved a mercantile operation.
In that case, a wholesale business that consisted of distributing houses in seven states and a central office in Chicago.
The Court found that the business was an integrated, unitary business because of the presence of centralized management, centralized purchasing, and centralized advertising, and for those reasons, the operations of all of the separate distributing houses were found to be integral parts of a single unitary business, so that in determining how much of the income was apportionable, or taxable, I should say, in California, apportionment was upheld.
Now, how does this case compare to Butler Brothers?
There is absolutely no centralized management in this case.
The record shows that with the possible exception of one officer of the Canadian subsidiary, that none of the officers of the foreign subs was also an officer of the parent company.
Unidentified Justice: I take it then if Woolworth just transformed itself into a holding company, and each of its stores in each of the 50 states was owned by a subsidiary, similar to those that are operating abroad, those subsidiaries should be treated as non-unitary also.
Mr. Goldman: No, Your Honor.
We are very emphatic in saying that the form of corporation organization should make no difference whatsoever.
The domestic retail business was conducted in an integrated fashion, with centralized--
Unidentified Justice: Well, I know, but suppose it was... suppose the operations in each of the states was actually carried on precisely like the operations of the subsidiaries abroad.
Mr. Goldman: --If those--
Unidentified Justice: Then you would have exactly the same result.
Mr. Goldman: --If those were the facts, then we would say that each state could... would be constitutionally barred from taxing any of the income earned in any other state.
Unidentified Justice: All right.
Of course, here you did have some interlocking directorates.
Except in the German.
Mr. Goldman: That's correct, Your honor.
Unidentified Justice: Why was that different from the others?
Mr. Goldman: My understanding is that the form of corporate organization there did not include a board of directors.
That is what the record suggests, that there were no directors of the German corporation.
Unidentified Justice: So if it had, you would have had--
Mr. Goldman: We would have had the opportunity to elect them as the controlling shareholders.
Unidentified Justice: --And presumably would have put them on as you did with the others.
Mr. Goldman: Well, the record shows that there was some, although not totally overlapping, that some interlocking directors.
I think what that shows, what that shows is that we owned the stock of the subsidiaries.
I mean, that is... there is no question about that, and in voting the stock we exercised the normal stewardship functions, the normal functions of an owner.
But if that per se made the dividends apportionable, then, contrary to this Court's statement in Mobil, dividends from all subsidiaries would inevitably be apportionable wherever the parent conducted its business.
Unidentified Justice: Was the management of the individual companies sort of integrated with the management of the entire organization?
At least, did they sort of rotate around?
Did you say, well, now, next year you are going to go run the store in Los Angeles, and maybe next year in Berlin?
Mr. Goldman: Exactly the opposite was the case.
Each subsidiary hired and trained its own officers.
There was an attempt by counsel for the state to develop a line of questioning that showed that perhaps at an operational level the director of purchasing from one company spoke to the director of purchasing from another, and that was refuted by the answers to the questions.
The record shows that the chief executive officer of the U.K. sub, at least to the witness's knowledge, had been in that position for at least ten years prior to--
Unidentified Justice: So none of the accumulated experience in marketing that the F.W. Woolworth Company had the advantage of ever was made available to these subs?
Mr. Goldman: --There certainly was no centralized management in the sense of operating all of the businesses in a cooperative fashion so as to maximize the profits of the whole.
It may be that as a member of the board of directors, one brings with him the knowledge he already has, but it wasn't employed in an operational sense.
There was no day-to-day control, no supervision, no rotating of managers from one store to another.
Absolutely not, Your Honor.
Unidentified Justice: They didn't call themselves Hans Schmidt, though, in Germany, did they?
They called themselves Woolworth.
Mr. Goldman: That's correct.
They had the same name, and each corporation conducted its own business in its country using the same name, and developed presumably whatever good will in that country accrued to its own--
Unidentified Justice: Why did they start out using the same name?
Mr. Goldman: --Why did they start out?
Unidentified Justice: Yes.
Mr. Goldman: The record doesn't show why they started out.
It does show that the U.S. company was organized around 1911, and that the U.K. company was organized about the same time.
Presumably the separate companies were started and operated in parallel fashion.
Unidentified Justice: Doesn't that show some effort, though, to capitalize on the value of the name?
Mr. Goldman: The answer... I can give you my own inference that it does not.
I can't point to a statement in the record that shows one way or the other, except to point out that in managing and directing each subsidiary, the management of each subsidiary was... catered to local tastes and local needs, and that in Germany, for example, there was an emphasis on soft goods, dresses, coats, and so on, because apparently that was found to be successful in Germany, and by comparison, in the operation of the U.K. stores, they had a supermarket and food operations, and that was considered to be part of a Woolworth's operation in the U.K. The operations were in fact dissimilar, and operated in a fashion that made sense in each country.
Unidentified Justice: Well, they wouldn't sell for coats in Phoenix, either, but you might in New York or Boston, I suppose.
Mr. Goldman: That's correct, Your Honor, but the point is that each subsidiary was functionally independent, was a self-contained unit, had its own management, its own purchasing, its own policy decisions as to the type and quantity of inventory to carry without regard or consideration as to what decisions were made along parallel lines in the operation of the same type of business in another location.
Unidentified Justice: In Germany, the name Woolworth would hardly be confused with a German organization, would it?
The local Germans would not think that was some local German merchant.
Mr. Goldman: I can't say whether a German in Berlin may think that... may know about the Woolworth operation in the U.S. or may ever have heard of it.
He may think it is totally indigenous to--
Unidentified Justice: Well, sometimes the use of a name is just a matter of family ego, is it not?
Mr. Goldman: --Well, the fact is that at least as far as the U.K. and the U.S. operations are concerned, they started out at the same time, so neither one was benefitting or could conceivably have benefitted from whatever name recognition there was, and there is no suggestion that in a retail type of operation which is essentially local, that there would have been any recognition on the part of a German resident of Woolworth as being a U.S. or having any U.S. connections at all.
For all we know, they may have thought there only was a German Woolworth.
The record is silent on that point.
Unidentified Justice: Mr. Goldman, would you concede that the domiciliary state could tax this income?
Mr. Goldman: The taxing jurisdiction of a domiciliary state and the taxing jurisdiction of a non-domiciliary state, which is what we are talking about here, stand on different footing, I believe, for due process purposes.
The taxing jurisdiction of New Mexico as a non-domiciliary state--
Unidentified Justice: Right.
Would you concede that the domiciliary state can tax it?
That is my question.
Mr. Goldman: --Yes, I would.
Unidentified Justice: In its entirety?
Mr. Goldman: For due process purposes, I would agree that the domiciliary state could tax the income because a domiciliary state is entitled to tax income that may have its source outside the domiciliary state, and so whatever its rights and prerogatives may be don't answer the question, however, as to the rights of New Mexico.
Unidentified Justice: All right.
What about the taxability in the non-domiciliary state of short-term investment income?
Mr. Goldman: If the short-term investment income can be said to be part of the operating income of the unitary business, then we agree, as we agreed with the dividends here in issue, if that were an appropriate conclusion, that the short-term investment income could be included in the apportionable income base.
Unidentified Justice: And under what circumstances would long-term investment income be treatable in the same fashion, in your view?
Mr. Goldman: If the underlying operations of these subsidiaries were sufficiently functionally integrated--
Unidentified Justice: All right, and on the short-term paper, buying Treasury notes wouldn't be taxable, the income?
Mr. Goldman: --If the short-term investment income resulted from the investment management of working capital, so that it was part of the cash flow operation of the business, we would agree that managing the cash flow of your business is sufficiently functionally integrated with your business so that the income from that type of short-term investment could be apportionable.
The reason it would be apportionable would be because of the type of activities that gave rise to it and their relationship to the business.
In this case, there is no relationship between the businesses of the foreign subsidiaries and the business, the domestic retail business in the United States, except for the fact that you have the same corporate owner, that Woolworth owns the stock, and if owning the stock of a sub that is engaged in the same line of business could give rise to apportionable income, then we think there is no room for an investment in an operating subsidiary.
We think it plain also--
Unidentified Justice: Mr. Goldman, may I interrupt you for a second?
In the other case, we talked a lot about an intermediate category.
I guess you heard the argument.
Do you understand the New Mexico Supreme Court to endorse that concept or to treat the subsidiaries in this case as part of the unitary business?
Mr. Goldman: --I don't believe that was at all the basis for the decision below.
I think the basis for the decision below was the court's conclusion that Woolworth cooperatively and jointly with the subsidiaries was conducting a single unitary business, and it felt for that reason that it could hold the dividends to be apportionable under Mobil.
Unidentified Justice: Then the two states really take a different position, because as I understood the Idaho argument, they would have agreed that the fact... the formula would be different in a case such as this.
Mr. Goldman: Well, I think the courts took a different approach.
I think the state in our case, if I may characterize their argument from their belief, agrees now that the businesses were not in fact part of a single unitary business, so the state will have to make its own argument this afternoon, but they were arguing at least through the New Mexico Supreme Court level and even in the briefs they filed in opposition to our jurisdictional statement that all the corporate entities here were cooperatively conducting a single unitary business, and I understand that they no longer take that position.
One point I would like to emphasize in connection with the opinion below, there is a statement in the decision of the New Mexico Supreme Court in describing the evidence relied upon by the state to the effect that there was some intercompany flow of goods, a statement which might suggest that there indeed was some functional integration.
In fact, the record absolutely refutes that, contradicts that, and that was just a misstatement of fact by the New Mexico Supreme Court, and again, we understand at this point, since we made that point rather emphatically in our brief, that the state agrees with us.
Unidentified Justice: You cited in your brief... does the other side concede that that is error?
Mr. Goldman: I believe so.
I believe so.
We think it plain under the decisions of this Court that if the operations of the foreign subsidiaries had been conducted directly in divisions of Mobil... excuse me, of Woolworth, rather than in subsidiaries, we think it plain that the income, the operating income of those divisions could not have been apportioned to New Mexico.
We think that by putting the divisions, putting the operations into subsidiaries, ought not to change the result.
We think that is the teaching of Mobil.
We think in Mobil what you held was where you have admittedly unitary operations generating income that would have been apportionable had they been conducted directly by the parent, then the apportionability of that income cannot be avoided by transferring the operations to a subsidiary, but we think the converse is equally true.
You can't take non-apportionable, non-unitary income and somehow make it unitary or make it apportionable by transferring the operations to a subsidiary.
We think that what the Court said was that the form of organization does not affect the underlying economic realities and cannot affect the apportionability of the income that the parent receives.
If I may, I would like to turn at this point to the Section 78 gross-up issue.
It is a technical issue, and it is covered at length in the briefs.
I would just like to make a few basic points about it.
Number One, I want to emphasize that unlike the state, our position with respect to the Section 78 gross-up amount is not dependent on your decision with respect to the apportionability of dividends.
If you hold that dividends are not apportionable, that automatically resolves the Section 78 gross-up question in our favor, but even if you should hold that some of the dividends may be apportioned, we still have all of our arguments with respect to the Section 78 gross-up amount.
The basic point that we make with respect to the Section 78 gross-up amount is that the taxpayer's federal tax liability is unrelated to its state tax calculation.
If the taxpayer receives an apportionable dividend of $100, that is the amount that gets included in apportionable income, and it is irrelevant for that purpose whether the associated federal tax liability was $5 or $50.
In all events you still include the $100 in apportionable income, but the Section 78 gross-up amount is related only to the computation of the federal tax liability.
It has no separate, independent existence of its own, and even if coupled with the foreign tax credit, it should reduce the foreign tax liability from $50 down to $5, you still can't increase as a consequence of that the amount of apportioned income... apportionable income actually received.
Perhaps I can move on at this point to our alternative arguments with respect to factor relief if the Court should hold that any of the income is includable in apportionable income.
I think the key point to be made here is that New Mexico can only tax income that can be fairly said to be attributable to the activities conducted in New Mexico, and if you include in the apportionable income base any income which is in fact attributable to activities conducted in Germany or in the U.K., then you should correlatively reflect the payroll, property, and sales that generated that income.
With the Court's permission, I will reserve the rest of my time for rebuttal.
Chief Justice Burger: Very well.
ORAL ARGUMENT OF SARAH E. BENNETT, ESQ., ON BEHALF OF THE APPELLEE
Mr. Bennett: Mr. Chief Justice, and may it please the Court, Woolworth has not attempted to prove that formulary apportionment as applied by New Mexico results in an attribution of an unreasonable amount of income to New Mexico.
Instead, it chooses to rest upon its contention that a reasonable, fair on its face, uniform apportionment formula is per se invalid when it includes dividends from investments representing shares of stock in foreign corporations it held in connection with the business of this taxpayer, and from related gross-up income in apportionable income of this unitary business.
The question presented is whether the statute as applied by New Mexico violates the due process clause.
Woolworth had choices in New Mexico about how to calculate its income attributable to New Mexico.
First, primarily it could have chosen to separately account for its income earned within New Mexico purely within the boundaries of that state.
It could and did chose to report its income under the unitary apportionment method adopted by the State of New Mexico.
Within the provisions and the boundaries of the Uniform Division of Income for Tax Purposes Act, there are still several alternatives available to this taxpayer.
Woolworth chose to report and characterize itself as a nationwide unitary business.
It reported its income to New Mexico on that basis.
It used the factors of its domestic corporation.
I think that Woolworth could have had another alternative in this case.
It could have chosen worldwide combination for reporting of its income and calculating the amount attributable to New Mexico.
Unidentified Justice: Was that one of the options on the New Mexico return?
Mr. Bennett: Yes, it is available to a taxpayer who is conducting a worldwide unitary business.
It may combine its income.
It may then include all the factors of the foreign corporations.
Unidentified Justice: Is that specifically in your statute?
Mr. Bennett: No, it isn't, but it is in the regulations.
What the statute says is that business income, and interpretation of a business is... we are dependent to some extent on the characterization by a taxpayer of what his business is.
Woolworth reported as a nationwide unitary business.
Finally, within the provisions of UDITPA, there is a relief provision.
If a taxpayer considers that application of a formula to it results in attribution of an unfair amount of income to New Mexico, it may prove that, and it will get relief.
Woolworth chose nationwide, and made no attempt at all to show that it was eligible for any kind of relief.
Due process requires two things of a taxing state.
It requires that we not overreach to tax a business which is not conducting business within the borders of New Mexico, and it requires that we not attribute too much income to New Mexico from business conducted there.
Woolworth has met neither of those two requirements of the due process clause.
Unidentified Justice: Ms. Bennett, may I ask you a question--
Mr. Bennett: --Yes.
Unidentified Justice: --about your theory and the theory of the New Mexico Supreme Court?
First of all, was it the New Mexico Supreme Court's theory that these foreign subsidiaries were part of the same unitary business as the American operation?
Mr. Bennett: The New Mexico Supreme Court found as a statutory matter that the income... the dividend income was business income of this unitary business.
I believe that it found that the fact that the worldwide business was unitary indicates further that the dividends received by this taxpayer from its investments--
Unidentified Justice: Your answer is yes.
Isn't that right?
Mr. Bennett: --indicate the business nature of those investments.
I think it is really important here to distinguish--
Unidentified Justice: Please, I just want to be sure I understand your answer.
Mr. Bennett: --Right.
Unidentified Justice: Your answer is that the New Mexico Supreme Court did consider the worldwide operation as part of one unitary business.
Mr. Bennett: Well, yes, but the business we are taxing here is not that unitary business.
I think that what the New Mexico Supreme Court recognized is that if in fact Woolworth is a worldwide unitary business, it is pretty clear that the dividends we are taxing here are business income of the unitary business that we are taxing in the taxing state.
Unidentified Justice: Well, if they are part of one worldwide unitary business, then their theory was somewhat different from the theory of the Idaho Supreme Court.
Would you agree with that?
Mr. Bennett: If in fact there was... yes, some distinction.
Unidentified Justice: And the Idaho Supreme Court left out the assets and property, payroll, and so forth from the subsidiaries because it regarded those as not part of the unitary business.
Now, why does New Mexico leave out these parts of the... the denominator from income generated by the same unitary business?
Mr. Bennett: I don't think this question can be answered without looking at the taxpayer that we are taxing.
I think that the question here is a precise one.
The taxpayer that is reporting to New Mexico is the nationwide unitary business.
I think that in this sense it is not necessary that the foreign corporationsthat represent... well, the corporations underlying the investments which Woolworth holds be unitary.
I think in this case they may be.
The question is, when you have a domestic unitary business and you don't have any indication that there are two businesses being conducted by that business that is reporting its taxes to the taxing state, whether or not we can include dividends as part of the apportionable business income of that business.
I think that the fact that Woolworth may in fact be... may include these foreign corporations as part of its unitary business indicates in a factual sense that the investments are hold for a business purpose, that they are part of the unitary business in this case, as it is reporting its income to the taxing state.
Unidentified Justice: Well, do you defend all parts of the New Mexico Supreme Court's decision or not?
Mr. Bennett: We support the concept that there may be a unitary business--
Unidentified Justice: Do you support their seeming view that this entire bundle of companies, including the foreign companies, were not a unitary business, or not?
Mr. Bennett: --Yes.
The only quarrel I have with the holding by the New Mexico Supreme Court is that that is the only question, that that is the controlling question in a situation like this.
If in fact there is a worldwide unitary business, and Woolworth considers itself to be a unitary business, it can report that way to New Mexico.
It can get factor relief.
It includes all the income earned by all the business.
It factors and apportions by all the factors relating to that worldwide unitary business.
We were stuck with a characterization that New Mexico gave itself, a domestic business.
That is the one that is being taxed.
Unidentified Justice: I know, but when they made the choice that they made, they operated on the assumption that dividends were not includable.
Mr. Bennett: Yes.
Were includable, or--
Unidentified Justice: So now would you let them change their... change?
Mr. Bennett: --The option was offered to them below.
I don't know if they can go back in this particular case and go and change it this way.
The taxpayer is presumed to know what the law requires, and in New Mexico the regulations are very clear that dividends are includable if they are obtained from investments that are acquired for a business purpose.
Unidentified Justice: For a business purpose.
Like making money?
Mr. Bennett: Making money is one aspect of it.
Unidentified Justice: Is that all you have to do to have a business purpose that would make the dividends includable?
How about from the hotel chain?
Mr. Bennett: The hotel chain is a good example.
The hotel chain, if we posit that the hotel chain is a separate corporation, and Woolworth invests its money--
Unidentified Justice: For a business purpose.
They want to make the money.
Mr. Bennett: --Well, I think the dividends in that sense are includable unless Woolworth--
Unidentified Justice: So you disagree with both sides in the previous case.
Mr. Bennett: --I think that the real test is not what the nature of the foreign... of the corporation underlying the investment is.
It is what Woolworth is doing.
What is Woolworth doing?
Unidentified Justice: Okay.
So you do disagree with both sides in the other case.
Mr. Bennett: I think that--
Unidentified Justice: They both seem to agree that the hotel chain wouldn't be, dividends from the hotel chain, unrelated to the mining company, would not be includable.
Mr. Bennett: --That is not my understanding of Idaho's position.
If they said that, I do disagree with it.
Unidentified Justice: You disagree with it.
If they said it, you disagree with it.
Mr. Bennett: I think that you have to look at the taxpayer that is operating and look at that business.
Woolworth could have shown that it had two businesses, and one of them was investing, for whatever purpose, and that could be a separate business under a particular given state of facts.
We don't have that here.
We have one integrated business.
They have always contended it to be an integrated business, conducting... conducting as a part of that business--
Unidentified Justice: To... in the United States.
Mr. Bennett: --earning, you know, conducting retail stores, making substantial investments.
Many of those investments it concedes to be business income.
If it is short-term, it is business income.
It seems to make the distinction on an illogical basis, the length of time that the investments are made, and the fact that they are big.
Unidentified Justice: You don't have any doubt about what Idaho's position was, do you, with respect to that point?
Mr. Bennett: I--
Unidentified Justice: Lay aside the hypothetical question about the hotel chain or the... some other kind of a chain, a supermarket chain.
The asbestos company in Canada, which was in the mining business, and producing the way materials and some finished product, they said was not subject, was not includable.
Mr. Bennett: --I don't agree with that conclusion.
I think that the question here is whether or not the investment activities are an integral part of the taxpayer's business.
That has been found to be true.
It is constitutional to do it that way.
Unidentified Justice: Well, as Justice White put it to you, if it is making money, then New Mexico is going to include it.
Mr. Bennett: Well, if it is making money to which business.
I mean, the business that we are talking about here is an integrated, unitary business.
Unidentified Justice: Well, the dividends are paid to the parent corporation--
Mr. Bennett: Right.
Unidentified Justice: --which you are taxing, so that is all you need.
All it needs to do is earn from its investment.
Mr. Bennett: We may presume that, we believe, to be true.
The taxpayer can show that it is earned in a different business.
Unidentified Justice: What is the New Mexico law that you are... it sounds to me like you are saying, if the parent company or the company you are trying to tax is earning income on any investment whatsoever, it is includable.
Mr. Bennett: If it is for a business purpose.
If it is related to the business.
Yes, and making income is one aspect of that.
Unidentified Justice: What contribution does New Mexico make to the total other than the sales and the operations within the borders of the state?
Mr. Bennett: Well, first of all, we don't know what the activities are in the state.
We don't have any evidence on what they do in New Mexico.
We know they operate at least one store.
We know they make $13 million worth of gross receipts in New Mexico in this taxing year.
But we do not know the extent of their activities within New Mexico.
But when a unitary business is operating nationwide and operates in a taxing state, it is not a question of how much income you actually earned in New Mexico, because it is presumed that all aspects of a unitary business contribute to the production of the total income, and that that income can be apportioned on a formulary basis, and New Mexico can tax its fair share by using a reasonable and fair apportionment formula.
Now, I don't think that there is anything different necessarily about dividends.
Investments are made for business purposes, it is known.
They increase the overall assets of the corporation.
A corporation with substantial assets is thereby better off, in a better position to make money in every state in which it makes money.
It is better able to absorb losses than a corporation without such assets.
The holding of intangible assets in many ways benefits a corporation.
So, the question is not, is it directly related to the taxing state.
That is a situs concept.
Unidentified Justice: I suppose it follows then that constitutionally every state in the country can do just what New Mexico is doing here.
Mr. Bennett: We believe so, as long as... especially here we have a uniform act, which apportions things, we hope, consistently, from state to state to state, and each state is taxing only a proportionate share of the amount of value there.
For things which have location, we make recognition in the factors.
We have a three-factor formula which we think includes most aspects of a unitary business, and does indicate fairly what proportion of the total business is earned in the taxing state.
Unidentified Justice: May I ask you a question about that?
Assume that our Mexican subsidiary in this case were in fact located in Texas instead of Mexico, and they contended it was an entirely separate operation, with separate management, no purchases, and so forth, and you concluded to the contrary, that it was part of the American unitary business.
Would you have taxed them the same way as you tax the Mexican company?
They paid the same dividends.
Mr. Bennett: Well--
Unidentified Justice: Would you have taxed dividends, or would you have pierced the corporate veil and looked through into income and assets?
Mr. Bennett: --We have a unitary business that reported, and they called them that.
We are talking... Are we talking--
Unidentified Justice: I understand all that.
I am just asking what you would have done in that hypothetical.
Mr. Bennett: --In that hypothetical, if the taxpayer wanted to recognize it as a corporation?
Unidentified Justice: He filed the return I described.
Mr. Bennett: All right.
Unidentified Justice: He described the Texas operation as a separate business, not part of the unitary business.
You investigated and disagreed.
What would have been the tax consequences?
Mr. Bennett: We would eliminate the intercorporate dividends, include the corporation as part of the unitary business, apportion by all the factors.
We could do the same thing worldwide.
We are glad to.
Unidentified Justice: So you wouldn't have done something different than you did with respect to the Mexican subsidiary.
Mr. Bennett: We are glad to do it--
Unidentified Justice: That is correct, is it not?
Mr. Bennett: --if it is a Mexican subsidiary.
Unidentified Justice: I want to be sure I... what?
Mr. Bennett: --No, I don't think it's... we don't treat Mexico--
Unidentified Justice: You told me that you would have pierced the corporate veil in the Texas hypothetical--
Mr. Bennett: --Well, no--
Unidentified Justice: --but you did not pierce the corporate veil with the Mexican case.
Why is there a difference?
Mr. Bennett: --The difference is only in the exercise of the state's power.
The state of New Mexico does not go out and redefine a taxpayer as a unitary business.
We accept it.
If a taxpayer reported a unitary business, and excluded one corporation that it owned, we very seldom challenge that analysis.
Unidentified Justice: Which is what it did in this case.
It excluded the Mexican subsidiary--
Mr. Bennett: For the same reason, we would not challenge the exclusion of a United States corporation.
It is a matter of the exercise of the state's power, and not--
Unidentified Justice: --Well, you just told me you would with respect to the Texas company.
Mr. Bennett: --We don't... we--
Unidentified Justice: You said you would there pierce the corporate veil.
Mr. Bennett: --We would agree to it.
Unidentified Justice: Why don't you pierce the corporate veil here?
Mr. Bennett: We would not enforce it.
That is the question.
Unidentified Justice: It is just a matter of discretion with respect to the taxing authority.
Mr. Bennett: The taxpayer chooses in New Mexico how to report a tax.
If the taxpayer wanted to include that, it could.
If it wanted to include worldwide, it could.
I think probably New Mexico constitutionally has the power to force it to.
New Mexico does not choose to exercise that kind of power.
We would recognize the Mexican subsidiary as a unitary part of the business in the same manner as we would recognize any domestic corporation as part of the unitary business.
We are dependent very much on the taxpayer's characterization, however.
Unidentified Justice: Do you think you would have had the constitutional power in my Texas example to decline to pierce the corporate veil and just accept the... throw the dividends into the pot without looking at the denominator?
Mr. Bennett: If that is how the taxpayer characterizes its business.
Unidentified Justice: No, no, the taxpayer in each case has characterized the unitary business as not including the subsidiary which you then find to be part of the unitary business.
And I am saying, can you constitutionally make such a finding with respect to a domestic corporation and then say, we will just look at the income, we won't look at the factors that generate the income.
Mr. Bennett: Yes.
Unidentified Justice: You think you can.
Mr. Bennett: Well, the factors that generate 37 it is the whole question.
What factors generated production of dividend income.
Unidentified Justice: Well, by hypothesis, we are talking about a unitary business.
Mr. Bennett: --But the taxpayer... How do we know that?
Unidentified Justice: You found it.
Mr. Bennett: We found it?
Unidentified Justice: Yes.
Mr. Bennett: We found it based on what?
We have to have evidence to show--
Unidentified Justice: Well, on your theory, counsel, the single store in New Mexico might lose $10 million a given year, but by applying your formula, they might have to pay a tax notwithstanding that New Mexico's contribution was to help produce a $10 million loss.
Is that not so?
If the store in Homburg, Germany, and in Birmingham, England, and a lot of other places made a lot of money?
Mr. Bennett: --Well, there are two related concepts that I have to address here.
Unidentified Justice: Well, that is an easy one to answer, isn't it?
Mr. Bennett: --First... well, the first question is, can we tax, you know, if they can prove by separate accounting that the store in New Mexico operated at a loss, can they defeat the whole purpose of formulary apportionment.
Unidentified Justice: Well, with the autonomous accounting type that has been described here, that wouldn't be difficult.
Each one would have its own accounting.
Mr. Bennett: We have a management of each of the stores.
The stores do not stand alone.
They have a management that makes decisions about how to operate their stores.
Unidentified Justice: Then your answer is, they could have a $10 million loss, definitely established by Certified Public Accountants, but still pay a tax on the apportioned--
Mr. Bennett: If in fact their evidence showed that the amount of income attributed to the state was an unfair amount, we would make adjustments for that.
Unidentified Justice: --I suppose the same might have been true with respect to Vermont taxing Mobil and the assets it had in Vermont.
I suppose Mobil could have hired some accountant to come up with the conclusion it suffered a loss, but I don't believe under the Court's opinion that would have impaired the state of Vermont's power to tax.
Mr. Bennett: Right, and in fact in Butler Brothers, look at what they did.
They showed that the distribution center in California was operating at a loss, and this Court recognized correctly that it is a unitary business.
All aspects contribute to income.
All... and it is fair to attribute the total income of that business by the factors giving rise to it.
I think there is a second--
Unidentified Justice: I suppose it would be the same result, counsel, under your approach if the so-called unitary business that you were taxing in this case, namely the domestic unitary business, everybody agreed and you would agree had no... had a loss, the entire unitary business.
Except for the dividends from abroad, the company had a loss.
The entire United States was in the red, but then comes the dividends from abroad.
You would still say New Mexico is entitled to a tax.
Mr. Bennett: --I think we are still indulging in separate accounting here.
I think that the fundamental problem in this is that we are throwing out the distinction between dividends earned from investments and the profits of the corporation paying those dividends.
They are distinct.
The corporation earns money.
It may pay any amount of dividends.
Those dividends do not have any necessary relation to the amount of profits earned by that corporation.
A recipient of dividends is receiving income from its capital investments.
It is analogous to many other kinds of income.
It is analogous to interest earned from your investment which is called a loan.
It is analogous to rents in some senses.
Unidentified Justice: So again the taxability of income according to New Mexico doesn't depend on any kind of an integrated relationship.
Mr. Bennett: Not with the foreign subsidiaries.
We are talking about an integrated relationship among all the aspects of the business doing business within the boundaries of the unitary business, and the unitary business has been described to us as the domestic one.
That is the one that has been taxed.
We think that this formulary apportionment fairly attributes income based on that.
Unidentified Justice: Would you address yourself, Ms. Bennett, to what is fair and reasonable about New Mexico's treatment of the gross-up income, this fictional figure?
Mr. Bennett: Woolworth argues that it is a per se violation to include gross-up, and I think we've got to look at what we did in this case.
New Mexico was faced with the problem of how you come up with a number that you call income.
What is the income of this business?
It is quantification of an abstract concept, and New Mexico decided to solve that problem by adopting the federal terminology, the federal definition.
What is income for federal purposes is income for state purposes.
We could do it differently.
Unidentified Justice: Well, of course, the federal government allowed credits and New Mexico doesn't, so how does that become a fair procedure for New Mexico?
Mr. Bennett: It is facially fair.
Gross-up is included by accident.
There are many other amounts which are included by accident.
If the due process standard is violated, we can make adjustments.
The due process concept is, have we attributed more than a fair and reasonable amount of income to New Mexico, and there is no showing in this case that we have done that.
In fact, Woolworth realized $13 million of gross receipts in New Mexico for the taxing year.
What we have done as a result of this formula is attribute $400,000 worth of income to New Mexico, a modest amount considering the activities of the taxpayer in the state.
Also, if the taxpayer wanted to, it could prove that that was an unfair amount, if it had some indication, some evidence that really that does not fairly reflect income from New Mexico.
There are adjustments which can be made.
Woolworth completely ignored any of the statutory alternatives available to it, especially in the light of having absolute choices that it could make about different ways to calculate its New Mexico income attributable to New Mexico sources, and chose instead to attack only one aspect of a number which does not indicate outside the whole what the income of this business is.
We have... If we subtract, as Woolworth wants us to do, this amount, we have a much lower amount, which has no necessary relation in itself to income earned by this unitary business.
There are many amounts included in federal taxable income.
Some work to the detriment of a taxpayer, and some work to the benefit of a taxpayer.
Accelerated depreciation is an example of something which will dramatically reduce your federal taxable income, and for state purposes, it will reduce the state coffers proportionately and dramatically, and it is an amount which has no constitutional significance.
It is an amount which relates to federal taxing policy, which all of these amounts are.
What New Mexico has done is determine that the total amount there has some indications of reasonableness.
If a taxpayer can show that it is unreasonable in a given case, we will make adjustments for that.
Unidentified Justice: May I ask, Ms. Bennett, you mentioned earlier that you have a Uniform Act.
Do all the states with a Uniform Act interpret the gross-up situation the way New Mexico does?
Mr. Bennett: No.
There are some which include gross-up.
There are some who have by statute decided to eliminate that amount.
Unidentified Justice: Does the Multi-State Tax Organization, whatever they call it, do they take a position on gross-ups?
I don't think they did in their brief--
Mr. Bennett: I don't think so.
I don't know if they have--
Unidentified Justice: --They haven't supported it.
Well, they filed an amicus brief supporting--
Mr. Bennett: --They did not address the gross-up issue.
Unidentified Justice: --They didn't?
Mr. Bennett: I don't think it's a question of constitutional significance.
The questions under the due process clause are two.
The one that relates to this situation is, is the amount attributable to the taxing state out of proportion to values located there.
It is a result-oriented approach.
If the taxpayer can show that the result is grotesque, is distorted, it certainly can get apportionment relief.
There is no showing here.
It is a fair amount.
Unidentified Justice: Well, is it your argument... I want to be sure I understand it... that you don't look at individual components of the return, you look at the end result, and if the end result seems fairly reasonable, the fact that they might have included $1 million of salary to the King of England would be irrelevant, if the total figures--
Mr. Bennett: Well, I don't think I'd go that far with it--
Unidentified Justice: --Well, why not?
Mr. Bennett: --but we don't have anything like that.
Unidentified Justice: Well, you have a fairly significant amount in gross-ups.
Mr. Bennett: Well, the federal government determined that it was an amount that was reasonably related to values of this particular taxpayer.
Remember that it is related.
Unidentified Justice: Well, they did it as an adjustment to calculate the amount of tax credits which should be given.
Mr. Bennett: Which... the taxpayer elected--
Unidentified Justice: But you don't give any tax credits.
Mr. Bennett: --to take this adjustment.
Unidentified Justice: Pardon me?
Mr. Bennett: The taxpayer elected to take this adjustment.
Remember, the gross-up goes hand in hand with receipt of dividends from your foreign corporations.
Unidentified Justice: Well, as I understood it, it was amount that they did not receive but they are treated as though they had received.
Isn't that correct?
Mr. Bennett: Well, yes.
The federal government deems it to have been received when a taxpayer elects to take as a credit--
Unidentified Justice: Well, did they deem it to be received, or did they merely require that it be reported on the return for the purpose of calculating the correct amount of the tax?
Mr. Bennett: --The federal government deems it to have been received.
It uses that language, and it calls it income for other purposes under the Code.
Unidentified Justice: Well, the Multi-State Tax brief says, Woolworth has raised no substantial federal question by arguing that the inclusion of gross-up dividends entitled to relief.
Mr. Bennett: That must be in the... at this... in the earlier brief filed by the Multi-State Tax Commission.
I had neglected that.
In their primary amicus brief, they didn't address the issue, but in their earlier... they filed two amicus briefs.
Unidentified Justice: Well, the question was whether they have a position on it.
Mr. Bennett: I am sorry.
I was mistaken.
Unidentified Justice: I don't say that they have abandoned it, do they, have they?
Mr. Bennett: I am sorry, I was mistaken.
Unidentified Justice: The statement Justice White read was from the motion to affirm, in support of the motion to affirm--
Mr. Bennett: --Right.
Unidentified Justice: --not from the brief they filed after the case--
Mr. Bennett: Right, I was referring to the brief--
Unidentified Justice: --So you were dead right the first time.
Mr. Bennett: --With regard to the apportionment question, there is no attempt to show that the apportionment results in unreasonable attribution of value.
I think that Woolworth's arguments that we must include certain factors, especially of reasonable, and we did make some adjustments in this case.
We reflected the dividends received here in the sales factor, in the denominator.
Woolworth had other choices for how to calculate its income tax for income attributable to New Mexico.
No facts support its contentions of unfairness in this case, and the facts demonstrate the other, that it is a manifestly fair result, and the changes which it advocates to the apportionment formula are unreasonable changes.
It wants to include the factors of the foreign corporations.
It is impossible to imagine a reason for inclusion of factors of foreign corporations unless we assume that dividends represent the profits of the corporation paying them.
They disclaim that argument.
They don't want to argue that dividends are not different from profits of the corporation paying them.
They recognize the distinction between dividends and the profits of the foreign corporation.
We must in order to be consistent in the law recognize the dividends are earned by the domestic activities of the domestic taxpayer.
As a commerce clause question, we submit Mobil conclusively disposed of the issue raised here, and that is whether Japan Lines dictates elimination of some of the amounts included here in apportionable business income.
The reason is because we are taxing domestic income.
We have apportioned domestic income, and we have calculated the amount of tax attributable to the State of New Mexico.
Woolworth seems to agree that if the apportionment formula calculates an amount of domestic income, the commerce clause does not apply.
Woolworth attempts to distinguish this case from the Mobil case by revoking its concession that for commerce clause purposes the dividends are attributable to some state within the United States.
It is reducing the question to a litigation... to a question of litigation strategy.
I think that Mobil's concession was a necessary concession.
If a domestic taxpayer has domestic income, obviously, some state in the United States must have jurisdiction to tax that income that is earned by the activities of the domestic Woolworth corporation.
Unidentified Justice: Is it possible that under this formula, if every state did exactly what New Mexico did, that some of these taxpayers would be paying taxes in more than one state on the same dollar?
Mr. Bennett: I don't think it's possible.
The income here is the domestic income of this business.
If it is apportioned among the 50 states, if all 50 states had this taxing scheme, there would be attribution of a reasonable amount, an alloquat share of the whole to each of the states in which the taxpayer does business.
The taxing scheme would result in fairness to the taxpayer in every state in which it did business.
And the states are moving towards this kind of uniformity in adjusting their apportionment formula when evidence produced indicates that an unreasonable result has been reached in a case.
Chief Justice Burger: Very well.
Do you have anything further, counsel?
ORAL ARGUMENT OF WILLIAM L. GOLDMAN, ESQ., ON BEHALF OF THE APPELLANT
Mr. Goldman: I will take just a minute of the Court's time.
I think the essential point I would like to make is that the state's case is totally dependent on corporate form and the choice of corporate form.
The state says that the underlying activities were not unitary.
That means the income couldn't have been apportioned had it been conducted in divisions.
The state says we could have filed a combined report, but of course that would have meant taking into account income unrelated to our unitary business, an antithetical concept to filing the combined report.
I think the essential aspect of the state's argument is that since these activities were conducted in subsidiaries, now somehow the dividends paid out of these non-unitary profits are taxable, and the full scope of implications of that argument is reflected by the statement that, yes, the state could have taxed income from an unrelated hotel subsidiary.
I think the state needed to give that answer to that question, because this case stands on the same footing with that question.
In both cases, the profits would be paid out of... the dividends would be paid out of profits earned in totally unrelated activities, and that is the sole question when you come to apportionment.
How are the profits earned?
We are allocating profits here, and if the profits were earned from unrelated activities, then they needn't be taken into account for purposes of the New Mexico tax calculation.
Thank you very much.
Chief Justice Burger: Thank you, counsel.
The case is submitted.