TRINOVA CORP. v. MICHIGAN DEPT. OF TREASURY
Legal provision: Article 1, Section 8, Paragraph 3: Interstate Commerce Clause
Argument of Peter S. Sheldon
Chief Justice Rehnquist: We'll hear argument now in No. 89-1106, Trinova Corporation v. Michigan Department of the Treasury.
Mr. Sheldon: Thank you, Mr. Chief Justice, and may it please the Court:
This case involves the constitutionality of a value-added tax, specifically the Michigan Single Business Tax, which is known more commonly as the SBT.
The case comes to this Court on stipulated facts from a decision of the Michigan Supreme Court that upheld the tax against petitioner's constitutional challenge.
There are two questions presented.
The first question is whether the three-factor property payroll and sale apportionment formula that is contained in the SBT taxes value added outside of Michigan and produces a grossly distorted result in violation of the Due Process and Commerce Clauses.
The second question is whether that same three-factor apportionment formula discriminates in favor of in-State businesses and against petitioner and other similarly situated out-of-State businesses by systematically and irrationally reducing the tax bases of the former, while systematically and irrationally increasing the tax bases of the latter.
The primary points we make are these.
First, the tax base of the SBT, like the tax base of all value-added taxes, consists primarily of site-specific components, and those site-specific components, principally compensation and depreciation, are readily susceptible to precise identification and allocation on a State-by-State basis.
They are site specific because you know where the labor is performed, and therefore where value added by the labor takes place.
You know where the depreciable plant is located, and therefore where value added by depreciable plant takes place.
For the average SBT taxpayer the record in this case shows that its tax base consists of compensation to the extent of 77 percent, capital to the extent of another 17 percent, and profit to a much lesser extent, only about 6 percent.
So you can see the site-specific components dominate.
And for Trinova, the petitioner in this case, those site-specific components are even more dominant, because here also the record clearly shows by stipulation that Trinova's tax base consisted of compensation to the extent of 102 percent, depreciation to the extent of another 11 percent, and profit, profit added not 1 cent of positive contribution to the value-added tax base.
And that is because Trinova, during the 1980 tax year that is at issue here, incurred a significant loss from its operations.
Unknown Speaker: Suppose the facts were different and profit produced the greatest factor.
Would the operation of the tax violate the Constitution as applied?
Mr. Sheldon: Perhaps not, Your Honor, if... if Trinova had had a tax base that was comprised of the profit component to a significant extent.
But in this case the contribution of profit to the value-added tax base component was zero.
In fact it was a negative contribution.
Now because these site-specific components are susceptible to allocation, there is no need to apportion that.
Unknown Speaker: May I interrupt to... to follow up on Justice Blackmun's question?
Is there an agreement between the adversaries in this case that in the general... throughout the general run of taxpayers that the site-specific components is around 90 percent?
Mr. Sheldon: It's not a matter of stipulation, Justice Stevens, but in the merits brief, appendix la contains a publication from the Department of Treasury that clearly sets forth for the average taxpayer what their components of tax base are.
And there, very clearly, the compensation component is dominant and constitutes approximately 77 percent of the average taxpayer's tax base.
Unknown Speaker: Mr. Sheldon, let me put this question in terms of one of the examples given in one of the briefs taken from a law review article, as I recall.
The statement was made that a tax upon... upon sleeping, measured by the number of shoes in your closet, is in fact a tax upon shoes.
Do you agree with that?
Mr. Sheldon: The point, Justice Scalia, is that a tax has to be analyzed, in testing its constitutionality under the Due Process and Commerce Clauses, in terms of its practical effect, in terms of its economic reality.
Unknown Speaker: Right.
Mr. Sheldon: And here, this tax, by whatever label it may be called, is in practical effect and more than anything else a tax on compensation.
Unknown Speaker: Well, suppose you, you could have... we have approved gross receipts taxes, right?
Mr. Sheldon: Yes, Your Honor.
Unknown Speaker: Now why isn't, why aren't they just as discriminatory against out-of-State, some out-of-State companies, and just as contrary to the other principles that you are urging as this tax is?
Mr. Sheldon: Well, a gross receipts tax is generally aimed at determining a tax base that relates to the gross receipts, the actual gross receipts that is derived from activity within the taxing State.
What we have here is not a gross receipts tax.
We have a value-added tax, and the measure of the tax base is something different from a gross receipts tax.
Unknown Speaker: The measure is the receipts in Michigan, right?
I mean, that's the measure that you complain about.
Mr. Sheldon: The tax base of a value-added tax base that uses the additive method of calculation, such as the Michigan SBT, is comprised of--
Unknown Speaker: What you claim distorts this is the fact that they are using Michigan sales, isn't that it?
Mr. Sheldon: --That is correct.
Unknown Speaker: But they could tax you 100 percent on Michigan sales, and we would say it's okay.
So if you view this as not really a tax on value added or on anything else, but just as a tax on gross receipts in Michigan, we would say fine.
So if you believe it's a tax on shoes rather than on sleeping, this is okay.
Mr. Sheldon: But it's not a tax on gross receipts, Your Honor, it's a tax on value added.
And when you look at the value added components of tax base, the principal component is compensation.
Unknown Speaker: Well, this, this is a tax on value added, the same way the first tax I mentioned to you was a tax on sleeping.
It doesn't matter whether they say its a tax on value added.
If they are measuring it by Michigan sales, it is a tax on Michigan sales.
And we have said that is okay.
Mr. Sheldon: But the measure of the tax, Your Honor, is not Michigan sales.
The measure of the tax, the tax base is the compensation payments that the taxpayer makes--
Unknown Speaker: You have no complaint about that, that is okay.
That isn't what distorts it here, right.
Mr. Sheldon: --What distorts it, Your Honor, is the inclusion of an equally weighted sales factor--
Unknown Speaker: Michigan sales.
Mr. Sheldon: --in the three-factor apportionment formula.
And what that equally-weighted sales factor does is that it skews the attribution of the major site-specific component of a value-added tax base, which is compensation.
Unknown Speaker: But Justice Scalia's point is that the State of Michigan could have disregarded the site-specific factors and taxed you solely on your gross receipts, and you would be right about at the same place.
In fact, you would probably be in worse shape.
Mr. Sheldon: But... that may be true, Your Honor, but the State of Michigan has not elected to tax gross receipts.
It has elected to tax value added, and--
Unknown Speaker: It's a tax on sleeping, you say, right?
Mr. Sheldon: --I am saying that--
Unknown Speaker: But you just acknowledged that that doesn't matter.
It doesn't matter what you call it.
What you measure it by is what the tax is imposed on.
Mr. Sheldon: --Your... Your Honor, and the measure of the tax is value added.
Unknown Speaker: This is a tax on sleeping, not on shoes.
Mr. Sheldon: The practical effect of the tax, we submit, Your Honor, is a tax on value added, and the only way that Michigan could exact a positive contribution of tax from Trinova in this case is by taxing extra-territorial value, which the Due Process and Commerce Clauses--
Unknown Speaker: Well, isn't there another answer to Justice Scalia?
Two different taxpayers, one situated as you are and another one with precisely the same gross receipts in Michigan, pay vastly different taxes.
Mr. Sheldon: --That's correct.
That's correct, Your Honor.
Unknown Speaker: So it's not a tax on gross receipts.
Mr. Sheldon: That is my point.
If this tax, as we contend, is unconstitutional because it taxes extra-territorial value and produces a grossly distorted result, or because it is discriminatory, the fact that Michigan could have imposed a plainly valid gross receipts tax and generated as much revenue as a result of that can't be used as a legal justification for excusing or saving the unconstitutional infirmities of this tax.
Unknown Speaker: Is it all that clear?
You keep calling this a site-specific tax.
Is it going to be conceded by the State that this allocation is so precise?
Suppose... these were sales people mostly in Michigan?
Mr. Sheldon: That is correct, Your Honor.
Unknown Speaker: Suppose that the sales people were very, very important in giving information to the manufacturing component in the other State about the design requirements for this glass.
And suppose that they contributed a very, very significant amount to sales and to the overall success of the company just by their contribution to what was happening back in Iowa.
It's not all that clear to me that this is site specific.
Mr. Sheldon: Your Honor, we acknowledge that sales activity, including, for instance, the intangible contributions of centralized management, functional integration, and economies of scale may indeed impact and influence taxpayer decisions that relate to the employment and deployment of labor, and to the acquisition and location of depreciable plant.
And we acknowledge also that sales activity and these other intangible factors may also influence taxpayer decisions as to the amount that may be paid for those value-adding activities.
But the fact nevertheless remains that when those taxpayer decisions are implemented, you will still know precisely where that value-adding activity takes place, and you will know precisely the amount of value added by that activity.
The influence or the efficiencies that may be generated by sales activity or by these intangible contributions of centralized management and the like will be reflected only in the measure of the profit component of a value-added tax base.
Unknown Speaker: Well, why is that necessarily so?
I mean it might be or it might not be.
You are saying that labor is so site specific that it must be, without variation, apportioned precisely to the amount of activity that is economically measurable by a payroll.
But that's just contrary to economic theory, isn't it, and to the concession that you just made that there are a lot of intangible factors that go to make up the success of a unitary business?
Mr. Sheldon: The intangible factors only impact on the measure of the profit component of a value-added tax base, which we acknowledge may be properly subjected to three-factor formulary apportionment.
But under value-added taxing principles, and indeed as confirmed by language that is contained in the Single Business Tax Act itself, and indeed even as the Michigan Supreme Court has noted, the measure of value added by labor and capital, specifically the compensation and depreciation contributions to those components, is the taxpayer's cost.
Unknown Speaker: I don't understand why that is.
Mr. Sheldon: Well, translated, the cost with respect to the labor component is what the taxpayer pays its employees for the services they have performed.
And with respect to depreciation, translated, the cost is the amount of capital consumed during the accounting period that is measured by tax depreciation.
The Single Business Tax Act itself, Your Honor, in section 9 specifically defines the contribution of labor to a value-added tax base in terms of what the employer pays its employees.
There is no transferred value concept that applies here.
There is no enhanced value concept that applies here.
The measure of value added with respect to the labor contribution is what the employer pays for.
And the same is true, and section 9 of the SBT confirms this, with respect to the depreciation component of the SBT.
Unknown Speaker: Is it your theory that the constitution requires that the State adopt the most precise mechanism available for apportionment, given the theory of the tax?
Mr. Sheldon: We say, Your Honor, that with respect to the site-specific components of a value-added tax base, there is no need to apportion them.
That is not to say that the State could not come up with an apportionment formula that might fairly reflect the contributions of labor and depreciation to Michigan, even though that formula might not derive an absolutely precise result.
If it didn't result in gross distortion, I don't think we would have a constitutional problem here.
But in this case, in this case application of the three-factor formula against petitioner's tax base for the 1980 year has attributed to Michigan compensation that is 39 times more than value added by petitioner's Michigan-based employees, and then it has attributed to Michigan depreciation expense that is 970 times more than the value added by the capital consumption that is association with petitioner's Michigan-based plant.
Unknown Speaker: How large does a discrepancy like that have to be before you say the Constitution prohibits it?
Where... where would you ever draw the line?
Mr. Sheldon: Well, Justice O'Connor, in the Hans Rees case, of course, a distortion of 250 percent, or about 2.5 times, was found to be significant, enough to justify a holding in the taxpayer's favor.
Here we have distortion that is many multiples of that.
It is between 39 and 970 times, depending upon which of these more--
Unknown Speaker: Suppose that the taxpayer did have a sizable profit, unlike the taxpayer we have in this case.
How should the State apportion that part of the--
Mr. Sheldon: --We have no quarrel with the application of the three-factor apportionment formula against the profit component of the value-added tax base, because, as this Court has observed on many prior occasions, and which we do not contest, income is difficult to source on a State-by-State basis.
And that again is because net income results from the coalescence of a number of different factors, some of which are site specific, but some of which, like centralized management, economies of scale, and the like, are not.
But as to the compensation and depreciation contributions to the labor and capital components of a value-added tax base, those items, unlike net income, are site specific.
Unknown Speaker: --Mr.... surely Michigan is entitled to take into consideration the fact that the sales activity of Trinova to purchasers in Michigan, presumably automobile companies, is going to bring in a great deal of revenue to Trinova, is it not?
Mr. Sheldon: Sales activity will derive revenue, that's right, Your Honor.
Whether it derives income is another point.
Unknown Speaker: Well, why does Michigan have to settle for income?
Why can't it talk about revenue?
Mr. Sheldon: Well, it has not talked about revenue here.
It could have if it wanted to.
It could have established as its primary business tax a tax on gross receipts, but it has not elected to do here.
Unknown Speaker: This is a tax on sleeping.
We keep coming back to that, but you answered that question the other way.
I thought you answered the question that even though you call it a tax on sleeping, if you measure it by the shoes it is a tax on shoes.
Suppose Michigan had never mentioned value-added tax.
Suppose it had never mentioned the fact that the tax base would be total compensation plus total capital cost plus... plus profit.
Suppose it had simply said for every business, for every company doing business in Michigan we are going to impose a tax that consists, a tax of 2 percent on the three... the three-factor formula, Michigan compensation over total compensation, plus Michigan capital costs over total costs, plus Michigan sales over total sales, divided by 3.
Suppose that's how the tax were described.
Would that tax be constitutional?
It never mentioned value added, it never mentioned what it is taxing, except it recites the factor.
And for anybody doing business in Michigan you pay that tax.
Mr. Sheldon: I'm not sure I understand the full hypothetical.
You described for me the factors, what I understood to be a property payroll and sales factor, and then said that there was going to be a 2 percent tax.
But what is the tax base in your question, Your Honor?
Unknown Speaker: The total value of the business divided by those... those three factors.
Mr. Sheldon: Well, if you define the total value of the business in terms of value added principles, like Michigan has done here, most of the tax base is going to be compensation, and that three-factor formula will inevitably cause gross distortion, because the sales factor... the reason that is so is because the sales factor provides absolutely no clue whatsoever as to where the dominant site-specific productive activity that underlies payments of compensation and depreciation, which are the lion's share of the tax base, take place.
There is no rational relationship.
And this Court has said on numerous occasions that an apportionment formula in order to be fair has to reflect a reasonable sense of how income or value is generated.
Here we don't have--
Unknown Speaker: Does that translate to the theory that a distortion is measured against the theory of the tax?
Mr. Sheldon: --No, the distortion is measured--
Unknown Speaker: Because it seems to me that that has to be your argument.
Mr. Sheldon: --The components of tax base... what we are taxing here is we are taxing productive activity that is undertaken by the taxpayer, and the tax itself defines productive activity in terms of labor costs, in terms of capital costs, and to a very much lesser extent in terms of profit.
That is what is being taxed.
And then it is saying now, what is Michigan's fair share of this total value-adding productive activity that the taxpayer is undertaking?
And it has said we are going to measure that by using an apportionment formula that is widely used to apportion income under an income tax act.
And the problem there is again the use of an equally weighted sales factor, because the value added by the labor contribution to a value-added tax base is sufficiently measured by the payroll factor alone.
And the value added by the depreciation contribution to the capital component is fairly reflected in the property factor alone.
Those are the dominant parts of the SBT tax base.
Statistics tell us so.
77 percent of the average SBT taxpayer's tax base is not income, it is compensation.
Because of that, when you throw into the mix an equally-weighted sales factor, you are adding to the mix in terms of assigning those values to Michigan something that is irrelevant and something that is going to cause distortion.
Because again, sales activity provides no rational clue whatsoever as to where the value-adding activity that underlies the payments of compensation and depreciation take place.
In addition and independent of the gross distortion that this tax generates, it also produces a discriminatory effect.
And here again the culprit is the sales factor.
For those labor-intensive businesses that have property and payroll factors which when averaged are greater than their sales factor, this formula will enable them to export out of Michigan some of their site-specific, value-adding activity, while for the labor intensive business that has property and payroll factors which when averaged are less than their sales factor, they will be forced to import into Michigan some part of their site-specific value-adding activity.
And what this means, what this means is that the out-of-State taxpayer that has the characteristics I have just described will pay more tax on its Michigan value-adding activity than will the in-State taxpayer that has the characteristics that I have just described.
And while that difference in tax responsibility is admittedly not the result of the application of different tax rates or varying exemptions or varying credits, nonetheless, the practical effect of the tax is the same.
And it serves to provide a direct commercial advantage, and an unfair one, to the in-staters, and it serves as well to exert impermissibly on out-of-State taxpayers the possibility and the inducement to make non tax-neutral decisions to locate their property and their work force in Michigan.
If I... if the Court doesn't have any additional questions at this time I would like to reserve the balance of my time for rebuttal.
Unknown Speaker: Very well, Mr. Sheldon.
Mr. Roesch, we'll hear now from you.
Argument of Richard R. Roesch
Mr. Roesch: Thank you Mr. Chief Justice, and may it please the Court.
Michigan levies a single business tax, so-called because it replaced seven previous existing taxes.
It is imposed upon business activities.
These business activities are measured by a so-called value add.
It is quantified by Federal taxable income, plus several deductions from gross income to arrive at Federal taxable income, namely compensation cost, depreciation cost, net interest expense, and net royalty expense.
Now in the case of a unitary multistate business, this--
Unknown Speaker: May I just interrupt you there?
Mr. Roesch: --Yes.
Unknown Speaker: You start by talking about the Federal income tax.
That is... is it not correct that for most businesses that is a small portion of the tax base?
Mr. Roesch: Yes, that's very true, Your Honor.
Unknown Speaker: So there isn't really a big disagreement about whether 90 percent of the items that are taxed are site specific.
Mr. Roesch: No, there is no disagreement.
In fact, the gross national product figures also say that 77 percent is compensation payments.
There's no disagreement.
To go on, in the case of unitary multistate business, this tax base which results is apportioned to Michigan by the standard three-factor formula of property, payroll, and sales.
Now, the question here is not does Michigan tax any discrete components.
The question here is very simply is Michigan taxing a unitary multistate enterprise.
Unknown Speaker: Can I ask you a question right there?
Assume we have a unitary multistate enterprise subject to the tax, and assume Michigan wants to impose a payroll tax on unitary businesses, nothing but a payroll tax, and 90 percent of the payroll is in Ohio and 10 percent is in Michigan.
Could they use the unitary formula to allocate such a tax, in your judgment?
Mr. Roesch: --Justice Stevens, if Michigan were to impose a payroll tax similar to a FICA tax upon payrolls, obviously Michigan wouldn't have a jurisdictional reach over Ohio components.
Unknown Speaker: Why not?
It's a unitary business.
You are just using the formula to allocate, and a salesman in Michigan probably bringing in all these sales.
What would be wrong with it?
Mr. Roesch: Wait, we are not... the Michigan tax is upon business activities.
It's an entirely different--
Unknown Speaker: Well, I am hypothesizing a payroll tax on a unitary business apportioned by the formula.
Mr. Roesch: --A payroll tax, if it were simply upon payroll specifically, could not be justified under the unitary business--
Unknown Speaker: But if it's payroll which is 90 percent and you add 10 percent more for profit, then it's all right to apportion it?
Mr. Roesch: --That's not what I am saying, Your Honor.
Unknown Speaker: You're not.
Mr. Roesch: What I am saying is that the Michigan tax is not upon compensation.
It is not upon depreciation.
It is not upon any particular element.
It is upon the business activities.
It is business activities that are apportioned.
Surely we measure these business activities not by net income; we measure it differently.
And we come right back to the unitary business principle.
If a... if a State seeks to tax the proportional activities within the State of a unitary enterprise, it may certainly do so by unitary apportionment.
In Mobil Oil, for example, this Court said the unitary business principle is the linchpin of apportionability, and that this allowed separate accounting for foreign source dividends.
Unknown Speaker: But the reason behind that was that it is impossible otherwise to find a fair way to apportion... to identify the site-specific nature of the profit, where the profit comes from, except by a formula.
But here you base this entirely on, 90 percent on factors that can be identified.
Mr. Roesch: The factors can be identified, but you cannot identify where the value is added.
For example, I believe it was your opinion in Moorman which pointed out that for all that appears the Iowa sales, the large sales may have produced much greater income, a much greater margin of income than the Illinois property and payroll.
And so it is here we cannot... there has been no separate accounting for value added.
There has been only a reference to separate accounting for so-called components for the two costs, compensation, which surely is the biggest cost, and depreciation.
But this Court already has said in Container Corporation and Amerada Hess, it said very specifically--
Unknown Speaker: What if the tax, instead of just value added, was a value added by labor tax, and then you apportion it.
You figure your salesmen produce much more of... then it would be all right, I guess.
Mr. Roesch: --A value added by labor?
Unknown Speaker: A value added by labor, and you use... your component is payroll.
And then you go ahead and apportion it by the formula.
Would that be permissible?
Mr. Roesch: I believe that very well might be.
But I pose even a better one.
Could Michigan say we are going to look at the major expense of the business, namely compensation, and we are going to go ahead and apply this major... to this major expense, to all of your $226 million in this particular case, we are going to go ahead and we are going to say of this expense there is attributable to Michigan 9 percent, the average of your insignificant property payroll and your 27 percent sales.
And I say most certainly Michigan could use that 9 percent as a measure of Michigan business activity.
And this is really what we have here.
We have here--
Unknown Speaker: Mr.... Mr. Roesch, is it accurate to say that this is a tax upon business activity?
It's a tax that is said to be measured... the tax base consists of, according to the Michigan law, total compensation plus total capital costs plus profit.
I read that as a tax upon compensation, capital costs, and profits, not a tax upon business activities.
Mr. Roesch: --Yes, Your Honor.
Unknown Speaker: It's the shoes, not the sleeping.
Mr. Roesch: Yes, Your Honor, but for purposes of... for purposes of measuring, for purposes of measuring how much Michigan may get of these items, they are not site specific.
Like I tried to say in Amerada Hess, this Court specifically noted that... that the cost of a unitary enterprise cannot be deemed confined to the locality in which they are incurred.
And this is, this Court has disallowed specific accounting for items either of income or cost.
So what I am saying is none of these items as such is site specific when I tax activity.
Unknown Speaker: That's fine, but does that mean that simply because you can't identify it precisely you don't even have to try to identify it approximately?
Mr. Roesch: If Michigan were to have separate taxes upon these components, and this is our major disagreement here.
Trinova views the tax as being one tax upon compensation, one tax upon depreciation, another tax upon interest and royalty expense, and they say we can identify where these, where all of these site specific... or site-specific costs are incurred, and therefore the State of Michigan must take that into account.
It can only tax a certain amount of compensation; it can only tax a certain amount of depreciation.
If this is what Michigan did, rather than imposing a tax upon the overall proportional business activities in Michigan, then most certainly Trinova would have an argument.
Then it could separate out these components.
This Court has never allowed in a unitary business case, has never allowed the sourcing of foreign source dividends in Mobil, or the functional separate accounting in Exxon v. Wisconsin, or the separate accounting for the stores in Butler Brothers v. McColgan.
In each case this Court has said that in a unitary enterprise we cannot identify where the tax base, at what link in the chain of multistate operations this tax base is generated.
And I submit that there is no way to say that the Michigan activities do not contribute the amount of value to... that is being taxed by the State of Michigan.
Unknown Speaker: But why wouldn't the same result follow from Justice Stevens' first hypothetical that he gave you where there was a tax just on compensation, but that there was an apportionment measure used based on income?
I don't know why you conceded at the outset that the State couldn't do that.
It would seem to me that any fair measure--
Mr. Roesch: It seemed to me that--
Unknown Speaker: --Unless you are saying, unless you are conceding, which is what I thought Trinova should be arguing, which is that the theory of the tax and the measure of the tax must be in correlation.
If they had conceded that I would have asked them what authority there is for that.
Mr. Roesch: --The theory of the tax and its apportion mechanism completely really unrelate.
If we're talking about value-added tax, the only theory is that we tax the difference between the amount of costs I have for raw materials and services throughout the business and the amount of my gross receipts.
The theory here is very simply you must pay for governmental services the social costs you generate.
And on income tax, we are talking of ability to pay, really.
So these are really when we are talking about the theories.
But as I understood Justice Stevens' question it was this, if the State of Michigan were to say we are imposing a straightforward payroll tax, then I would believe that Michigan, if on the straightforward payroll tax let's say of 1 percent upon, could only tax the Michigan payroll.
It couldn't reach outside and tax Nebraska payroll or Iowa payroll.
Unknown Speaker: Well, suppose it was done on a formula that would, when applied by other States if they enacted a similar tax, was equitable to all.
What would be wrong with it?
Mr. Roesch: If... if you have no internal consistency problem, and that is what your question really implies, if other States enacted a similar tax and we would have... and it would be equitable, then I would have no hesitation to say yes, a State could enact that.
I am going now to Container Corporation.
Container Corporation requires apportionment formula to be both internally and externally consistent.
You know what that internal consistency means?
That if all the States enacted a similar apportionment device there would be no great overlapping of tax base.
There would be no multiple taxation.
External consistency the Court has interpreted as being that the factors used in the apportionment formula must be related to the ultimate activities here.
And I believe, for the taxing subject, I believe that when Michigan says we are taxing you upon your business activities which you are conducting in Michigan, and a certain proportion thereof is attributable to Michigan, that it can use certainly the three-factor formula which this Court, once again in Container Corporation, called a benchmark.
I believe that averaging the three factors of property, payroll, and sales truly does reflect the activities which a corporation or any business conducts within the State.
And I believe that a State is justified in asking a return in such an event.
Unknown Speaker: You may successfully argue that Michigan isn't reaching beyond its borders to tax, but you still have to answer the question of whether it discriminates against... against--
Mr. Roesch: --The discrimination argument can be answered very simply once again as it was answered in Moorman.
The discrimination argument hinges completely upon acceptance of the requirement of separate accounting for this type of a tax.
If no separate accounting is required, then obviously the Michigan... there is no discrimination, because the out-of-State industry cannot show that the out-of-State industry is burdened more than in-State.
The other coin... the other coin that we have here is the alternative argument, which presupposes a two-factor formula.
A two-factor formula ends up, as noted on page 44 of our brief, with a tax of $5,199 for doing a business resulting in over $104 million of revenue to the State... to Trinova.
Now, this $5,199 on top of it would never change, because it is only property and payroll, whether Trinova sold $100, $1 million, or $100 million in this year.
Now such a two-factor formula in my estimation would really... it may pass constitutional muster, but would not really reflect any kind of business activity, because I believe that the social costs generated by sales of $100 million, just the use of the courts, the highways, the schools, are much greater than the social costs generated by a sale of $100.
And yet the two-factor formula would lead to that particular result.
Now, I think that Moorman very clearly answers the discrimination argument by noting that the only way you can show discrimination is if you say that the Michigan formula, that the Michigan formula... that you must look to other formulas to see that the Michigan formula is discriminatory.
Unknown Speaker: --Of course, Moorman was an attack on the apportionment formula.
It didn't have anything to do with the tax base, did it?
Mr. Roesch: No.
Unknown Speaker: And here the basic attack is on the way that the tax base distorts the whole thing.
Mr. Roesch: Your Honor, Your Honor, you are correct.
Moorman had not included the tax base.
But let's talk about tax base for a minute.
Tax base in Michigan obviously could be apportioned gross receipts, and indeed apportioned gross receipts, [inaudible] tax as so, apportioned gross receipts were the measure of the tax upon the doing of business in the 1959 Second Railway Express case v. Virginia.
In that case this Court upheld the Virginia tax which was measured by apportioned gross receipts, namely total gross receipts of Railway Express apportioned to Virginia by a mileage ratio.
So obviously, if... if gross receipts may be apportioned, and obviously if net income may be apportioned, then something in between--
Unknown Speaker: But of course the purpose of the apportionment of the gross receipts there was to find out how many of those receipts took place within the taxing jurisdiction.
Here we know how many of the... how much of the compensation and how much of the depreciation took place in the taxing jurisdiction... virtually none.
Mr. Roesch: --That is correct, Your Honor.
But we are not taxing, once again, the depreciation.
We are not taxing... we are only looking--
Unknown Speaker: And here we are not taxing gross receipts.
We are just using sales as one of the factors for apportioning that which we assume otherwise could not be apportioned.
Mr. Roesch: --That is correct, Your Honor.
We are not taxing the total gross receipts, but we are taxing a goodly portion of gross receipts.
Indeed, the Michigan SBT has a nice distinguishing feature.
It says at the option of the taxpayer he may pay upon 50 percent of his gross receipts.
Now this option really is only taken by a taxpayer whose so-called value added would exceed 50 percent.
So really what we have is in effect a gross receipts tax limited to 50 percent of gross receipts.
Now, in this connection I cannot see very much difference here between the New Jersey case, Amerada Hess, and between the... the Michigan tax which is involved here with the SBT.
In New Jersey what we had, we had a so-called New Jersey net-income measure.
But in New Jersey net income was augmented by the special deductions for net operating loss and other special deductions, plus the Federal income tax and the Federal windfall profits tax.
Now, in that case what you really had, you had an income tax which was augmented by costs of the business.
And this Court... what was stressed in this Court was that windfall profits tax was site specific, it should be excluded from the preapportionment tax base.
This Court disagreed.
It said in a unitary enterprise the costs are no more site specific than the income elements may be deemed site specific.
And it upheld the New Jersey tax.
Now in this case what we have is we also start with Federal taxable income.
It is only that we have different additions to Federal taxable income.
What we have is a compensation addition and a depreciation addition.
And these expense additions, they form the tax base.
And these, obviously, if the windfall profits tax could not be... a cost could not be deemed site specific, it is hard to see why depreciation and compensation, which are also costs, should be deemed site specific.
Unknown Speaker: Except the additions here are 90 percent of the total, and in the typical income case your addition is a very small percentage of the total.
Mr. Roesch: Yes, but it has never been the rule that your apportionment, that the factors in your apportionment factor be reflected in the tax subject, in the tax base.
That has never been the rule.
It would never even be with the special industries, because mileage formulas really do not reflect, for example, any particular property or payroll.
Unknown Speaker: Well, wasn't it hoped in Michigan that adopting this particular tax might... might attract some business to the State?
Mr. Roesch: The hope was--
Unknown Speaker: As a matter of fact, hasn't it?
Mr. Roesch: --That is very hard to say.
It may have attracted some business to the State, but--
Unknown Speaker: Wasn't it hoped that it would?
Mr. Roesch: --It was hoped that it would.
Unknown Speaker: And the reason was because it would be more favorable to be located in the State than to be located outside the State.
Mr. Roesch: That is incorrect, Your Honor.
That's incorrect, Your Honor.
Why do you think for a minute--
Unknown Speaker: You don't need to ask me a question.
Mr. Roesch: --Thank you, Justice White.
No, I was just going to mention that the large plants with the small compact cars of General Motors were not built in Michigan, they were built in Tennessee.
So obviously all this attraction didn't really work out.
It was not meant to discriminate in favor of Michigan.
If Michigan wanted to discriminate it would have--
Unknown Speaker: Well, why did you adopt this new... this scheme replaced something else, like an income tax.
Mr. Roesch: --Yes.
Our income tax in Michigan was... was unpredictably cyclical.
There were years in which Michigan got practically no income from its corporate income tax, and then boom years it got a lot.
It also replaced the net worth tax in Michigan.
That was the only stable tax that we had in Michigan.
It replaced a tax... but that tax was disliked by the, by all the business community, in State and out State.
It also displaced a tax upon intangibles, mainly accounts receivable for the business.
And finally a tax upon their business inventories, which was a property tax, which is really an anachronism because most States have repealed their personal property taxes, particularly upon inventories.
Now this was also a tax simplification.
Instead of having to deal with all of these taxes, the taxpayer now had to deal only with one tax.
This tax would be more... much more stable, because... like a gross receipts tax would be extremely stable.
And so anything that is a modified gross receipts tax, which you can view this SBT as a modified gross receipts tax, also is much more stable.
It is not subject to fluctuations that base, like income, is subject to fluctuations.
It was hoped that because of simpler tax simplification, also because the businessman could more closely forecast his tax liability, that this would in itself be greatly attractive to industry.
But there was no design to try... in the Single Business Tax, to bring business into the State, to, in the words of Westinghouse v. Tully, to exert an inexorable hydraulic pressure to have business performed in the State rather than out of State.
Quite to the contrary, if Michigan had done that it probably would have adopted a flat sales factor the way Iowa has, for example.
That would really have... that really would have been an encouragement to perform in the State and sell out of State.
And yet this Court upheld in Moorman the single factor sales formula.
Now, ultimately what this case boils down to is that while Trinova admits that separate geographic accounting is not permissible for an income tax, that it should be constitutionally required when we have other than an income tax, that if we have a tax like Michigan which can be viewed as either an income augmented by cost tax, modified gross receipts tax, or, as the Michigan court puts it, a tax upon the value added to products and services.
Now, Trinova's separate accounting argument really results in converting an admitted value added, an admitted tax base of $221 million, into a Michigan loss of $2 million.
Trinova pays no Michigan tax for the privilege of doing $104 million worth of business in the State of Michigan.
That is the consequence of the separate accounting argument.
In Butler Brothers v. McColgan the Court was faced with the same idea.
It was faced also once again with that idea in Exxon v. Wisconsin.
And in each one of these cases the Court flatly disallowed converting a preapportionment tax base positive into a negative loss within the State.
Realizing that the separate accounting theory might not be accepted, Trinova evolved a secondary argument which is inconsistent with its separate accounting theories.
It evolved the argument yes, maybe apportionment is proper for our value added.
But they say it should only be apportioned by a two-factor formula.
But as I noted before, and as explained on page 44 of the State's brief, such a two-factor formula would produce exactly the same amount of tax whether or not there was any substantial sales activity in Michigan by Trinova, whether they sold $1,000, $1 million, or $100 million worth of sales in Michigan.
In Complete Auto Transit, in Complete Auto Transit this Court tried to get away from looking to the labels of a tax and said we are going to look at a practical effect of this tax.
And yet the whole argument here is on labels.
It is admitted that if Michigan imposed a straightforward income tax it could use the three-factor formula.
If it imposed a gross receipts tax, sure it could use a three-factor formula.
A net worth tax, as it did impose previously, a three-factor formula may be applied.
Unknown Speaker: May I ask you, you say a three-factor formula for gross receipts tax?
Why would you need a three-factor formula?
Mr. Roesch: Your Honor--
Unknown Speaker: There isn't a precedent for that, is there?
Mr. Roesch: --No.
Unknown Speaker: I thought all the formula unitary business cases were all income tax cases, because you need some formula to allocate the income.
You don't need a formula to allocate gross receipts.
Mr. Roesch: Your Honor, you are correct.
The three-factor formula has only been applied in income tax cases.
On gross receipts the only case that I know of and I mentioned was Railway Express v. Virginia, which did use a mileage apportionment--
Unknown Speaker: It was mileage, which--
Mr. Roesch: --against total gross receipts, meaning gross receipts may be apportionable as a measure of business activity.
Unknown Speaker: --Right, if you have some reasonable method of apportioning it.
Mr. Roesch: That is correct.
Unknown Speaker: And there is some relationship to predicting how many of the gross receipts were from that particular State.
Mr. Roesch: Well, the State was taxing business activity, and it said we are going to tax this business activity not by taxing a portion of your income, but a portion of your gross receipts.
Unknown Speaker: Right.
Mr. Roesch: And Michigan here says the same thing.
We are going to tax that portion of your business activity attributable to Michigan not by measuring it by income or even gross receipts, but by something in between.
Now the practical operation of the tax, Trinova pays 28.5 cents per $100 of sales, less than 3/10 of 1 percent.
And I could tell you by statistics... well, it is said and it is admitted that the Michigan business on the average will pay over 4/10 of 1 percent in terms of gross receipts.
Unknown Speaker: Because they'll have a bigger proportion of their other two factors in Michigan.
Mr. Roesch: That is possible, Your Honor.
Unknown Speaker: Well, that's the whole answer, isn't it?
Mr. Roesch: No, that is not the whole answer.
Let us take in-State Michigan business, completely intrastate business.
It also pays over 4/10 of 1 percent.
Now, I can contemplate, I am talking about the practical operation of the tax.
I can contemplate a practical operation of this tax whenever I wash the windshield of my 1980 Oldsmobile.
I knew that Trinova sold this window glass, this windshield, to the General Motors plant, the Oldsmobile plant in Lansing, Michigan, for about $100.
And I know that the value it has added to this windshield is about $56.
Now Michigan, instead of using the $100, uses the $56 to apportion to itself a certain amount.
When I look at this $100 windshield, I say for this business in Michigan, the State of Michigan is extracting from you $28.5 cents.
I think that is a modest recompense for the privileges and protections afforded by the State.
If there are no more questions I will end my argument.
Unknown Speaker: Thank you, Mr. Roesch.
Mr. Roesch: Thank you, Mr. Chief Justice.
Unknown Speaker: Mr. Sheldon, do you have rebuttal?
Rebuttal of Peter S. Sheldon
Mr. Sheldon: Thank you, Your Honor, I do.
Just because a business is a unitary business does not mean that the tax bases of every tax to which it may be subject must be apportioned.
I don't think anyone will argue that a real property tax, or a tax on immobile tangible personal property, or a severance tax that is imposed against a business has to be apportioned just because the business is a unitary business.
Here the practical effect of this tax is not a tax on business activity.
That is merely the legal justification, the legal excuse, if you will, for Michigan to be able to impose a tax against those businesses that are conducting business in the State.
The practical effect of the tax is that for most taxpayers it is a tax on compensation, and a tax on compensation is like a tax on payroll.
And a tax on payroll is, in practical effect, no different than a tax on real property, or on immobile tangible personal property, or a severance tax.
And like those taxes, it too should not be subjected to apportionment.
You need not apportion it.
Amerada Hess, the point is made that this Court said in Amerada Hess that the cost of unitary business and whether those costs are or are not site specific is irrelevant in determining their contribution to an income tax base.
But Amerada Hess involved a New Jersey statute, a taxing statute that was clearly an income tax.
It wasn't even close to what the Michigan SBT is.
Even after you denied the deduction for the windfall profit tax deduction, what was left of the New Jersey tax was plainly an income tax measured by Federal taxable income with just the one deduct taken away for windfall profit tax.
Here we have a value-added tax where 90 percent of the tax base, over 90 percent consists of site-specific components, principally compensation.
The point is Amerada Hess does not stand for the proposition that site-specific components of a value-added tax base have to be apportioned, or that their site specificity is irrelevant.
Counsel claims that, look, Trinova had $104 million of sales in Michigan this year, during the 1980 year, and the SBT as applied to it exacted a tax that amounted to 3/10 of 1 percent of its sales.
So what has Trinova to argue about?
Well, what Trinova has to argue about is that this tax is not a gross receipts tax.
It's a tax on value added.
Appendix 3a of our merits brief clearly discloses that the gross receipts alternative is only available to a small fraction of Michigan taxpayers, less than 10 percent use this gross receipts alternative.
So in practical effect we're not talking about a gross receipts tax.
We're talking about a value-added tax.
And the only way, the only way Michigan can exact 1 cent of tax from Trinova is to tax its extraterritorial value, the value that it has added to the contributions of its labor and its capital outside of Michigan.
Chief Justice Rehnquist: Thank you, Mr. Sheldon.
The case is submitted.
Argument of Speaker
Mr. Speaker: The opinions of the Court in two cases will be announced by Justice Kennedy.
Argument of Justice Kennedy
Mr. Kennedy: The first case is No. 89-1106 Trinova Corporation versus Michigan Department of the Treasury.
The case comes to us on writ of certiorari to the Supreme Court of Michigan.
Michigan levies its single business tax upon entities which have business activity within that state.
The single business tax is known as a value-added tax.
Tax payers such as petitioner, Trinova a major company, they have operations both within and without Michigan must determine the portion of their tax base attributable to Michigan under a three-factor formula.
This formula considers property payroll and sales in Michigan and allocate some Michigan tax, by computing these to the tax payer's property, payroll, and sales nationwide.
In 1980, Trinova had little property and payroll within Michigan but made sales of over $100 million in that state.
The three-factor apportionment formula attributed 9% of Trinova's total business activity to Michigan.
Trinova paid its tax to Michigan, and later brought this refund claim in a challenge to the apportionment formula.
Relying upon the due process and commerce clauses, Trinova first contends that apportionment is unwarranted because the tax base is largely composed of the elements of compensation and appreciation, and that these items can be geographically located.
We reject that argument.
The premise that the Michigan tax can be analyzed, as if it were separate taxes upon compensation, depreciation and income is not found.
The taxes upon a different bona fide measure of business activity, the value added.
The tax base includes the element of income which cannot be geographically located, but the result that the tax base as whole cannot geographically located.
Trinova's approach would distort the theory of the tax and will not adequately account for the contribution of Michigan's sales to value added.
Second, Trinova contends that even a sum of portion that were acceptable, the three-factor formula employed here lacks the required rational relation to Trinova's business activity in Michigan.
We have rejected similar challenges to the three-factor formula in the income tax context.
Our reason implies also where the formula is used to apportion value added.
Further, Trinova has failed to provide an alternative apportionment which would give any effect to its Michigan sales or acknowledge that value added is more than merely compensation plus depreciation.
Finally, Trinova cannot demonstrate any facial discrimination or other violation of our tests for unconstitutional discrimination against interstate commerce.
The judgment of the Supreme Court of the State of Michigan is affirmed.
Justice Scalia has filed in an opinion concurring in the judgment.
Justice Steven has filed a dissenting opinion in which Justice Blackmun joins.
Justice Souter took no part in the consideration or decision of the case.