Leathers v. Jacuzzi, Inc.

Timothy J. LEATHERS, Commissioner, Arkansas
Department of Finance and Administration v.
JACUZZI, INC.

96-136                                             ___ S.W.2d ___

                    Supreme Court of Arkansas
               Opinion delivered December 16, 1996


1.   Taxation -- 1982 instruction booklet did not provide for
     filing combined returns -- chancellor erred in so finding. --
     Appellant's contention that the chancellor erred in finding
     that its 1982 instruction booklet provided for filing of
     combined returns was correct; the instruction booklet stated
     that "DISC corporations are treated as regular business
     corporations" and "Business corporations, financial
     institutions, domestic insurance companies and DISC
     corporations should use Ark. Form 1100 CT"; the booklet thus
     indicated that the two corporations should have each filed a
     separate return.

2.   Taxation -- appellant's refusal to allow four combined returns 
     was not because corporations had in effect filed consolidated
     returns -- chancellor erred in so finding. --  
     Appellant's contention that the chancellor erred in finding
     that the Department refused to allow the four combined returns
     on ground that the corporations had in effect filed
     "consolidated" returns was correct; in refusing to allow the
     corporations to file the amended combined returns, the
     Commissioner noted that Arkansas statutes authorize
     consolidated returns, but, Arkansas Corporate Income Tax Law
     does not specifically require or allow combined reporting;
     therefore, the Revenue Division would not utilize unitary
     combined reporting to tax multistate or multinational
     corporations; also, the Revenue Division would not accept
     returns filed on a unitary combined report basis.

3.   Taxation -- combined reporting -- differentiated from
     consolidated reporting. -- Consolidated reporting is based on
     the principle that a group of corporations is taxed on their
     consolidated taxable income, representing principally the
     results of its dealings with the outside world after the
     elimination of intercompany profit and loss; in a combined
     report, the combined income of the affiliated group is not
     computed for the purpose of taxing such income, but rather as
     a basis for determining the portion of income from the entire
     unitary business attributable to sources within the state that
     is derived by members of the group subject to the state's
     jurisdiction; a combined report is an accounting method
     whereby each member of a group carrying on a unitary business
     computes its individual taxable income by taking a portion of
     the combined net income of the group; a consolidated return is
     a taxing method whereby two corporations are treated as one
     taxpayer.

4.   Taxation -- statute cited by chancellor did not support his
     ruling -- Ark. Code Ann. 26-51-805 (1987) did not mandate
     filing of combined return or filing of any specific type of
     return. -- The chancellor's ruling that combined returns were
     mandated under the facts so as to achieve a clear reflection
     of income and expenses of the two corporations pursuant to
     Ark. Code Ann.  26-51-805 (1987) was in error; the cited
     statute involved consolidated corporate income tax returns;
     consequently, it did not support the chancellor's ruling that
     the statute "mandates" the filing of a combined return; the
     statute did not "mandate" the filing of a combined return or
     the filing of any specific type of return. 

5.   Taxation -- combined reporting -- Ark. Code Ann.  26-51-718
     contains discretionary provision upon which combined reporting
     can be allowed -- statute found to be permissive in terms of
     allowing state to accept combined reporting. -- Although there
     is no express provision in the Uniform Division of Income Tax
     for Tax Purposes Act that required or allows combined
     reporting, Ark. Code Ann.  26-51-718 contains discretionary
     language upon which combined reporting can be allowed; the
     administrative law judge found that the foregoing statute was
     permissive in terms of allowing a state to accept "combined
     reporting," and the appellate court did not disagree with this
     interpretation.

6.   Taxation -- combined method of apportionment consistent with
     apportionment method -- Commissioner has discretionary power
     to require or permit apportionment on combined basis of income
     of taxpayer that is part of unitary business. --  The combined
     method of apportionment reporting is wholly consistent with,
     and a natural extension of, the apportionment method; the
     absence of any statutory reference to the unitary method of
     reporting does not forbid its use; unity of the use and
     management of a business that is scattered through several
     states may be considered when a State attempts to impose a tax
     on an apportionment basis; the enterprise of a corporation
     that manufactures and sells its manufactured product is
     ordinarily a unitary business, and all the factors in that
     enterprise are essential to the realization of profits; the
     entire income of a corporation, generated by interstate as
     well as intrastate activities, may be fairly apportioned among
     the States for tax purposes by formulas utilizing in-state
     aspects of interstate affairs; Ark. Code Ann.  26-51-718
     (1987) grants the Commissioner the discretionary power to
     require or permit the apportionment on a combined basis of the
     income of a taxpayer that is part of a unitary business.

7.   Taxation -- chancellor erred in ruling that appellee's filing
     of combined returns was not prohibited by law -- appellee
     failed to petition appellant for permission to use combined
     method. -- Appellee was not entitled to the relief granted by
     the chancellor because it did not apply to the Commissioner to
     be permitted to use the combined reporting method of
     accounting in accordance with section 26-51-718; Ark. Code
     Ann.  26-51-718 deals with the allocation and apportionment
     provisions of the UDITPA section; a taxpayer who wishes to
     deviate from the standard formulary apportionment has to
     petition for a change; a taxpayer cannot petition by filing a
     return.

8.   Administrative law & procedure -- proper judicial review of
     administrative agency of executive branch -- trial court
     exceeded its authority -- reversed and remanded. -- The
     appellant is a part of the executive branch; in a judicial
     review of the action of an administrative agency of the
     executive department, a trial court cannot, on appeal,
     substitute its judgment for that of the executive department,
     but is restricted to considering whether, as a matter of law,
     the agency acted fraudulently, arbitrarily, or capriciously,
     whether the administrative action was substantially supported
     by substantial evidence, and whether the agency's actions
     were within the scope of its authority; here, the judicial
     branch attempted to exercise the power of the executive
     branch; the case was reversed and remanded. 


     Appeal from Pulaski Chancery Court; Collins Kilgore,
Chancellor; reversed and remanded.
     Joyce Kinkead, for appellant.
     Friday, Eldredge & Clark, by:  James M. Saxton and Barry E.
Coplin, for appellee.

     Robert H. Dudley, Justice.
     The sole issue in this case is whether Jacuzzi, Inc., and
Jacdisc, Inc., its domestic international sales corporation, are
entitled to file combined income-tax returns.  The Arkansas
Department of Finance and Administration policy does not permit
combined returns, and the Department did not authorize the
corporations to file combined returns.  The administrative law
judge upheld the Department's actions and ruled that the two
corporations could not file combined returns.  The chancellor
reversed on the ground that combined returns would give a "clear
reflection of income and expenses" of the two corporations.  We
reverse.
     Jacuzzi, Inc., has multistate and multinational sales and
operations.  It formed Jacdisc, Inc., as a wholly owned subsidiary
domestic international sales corporation, or DISC, to take
advantage of federal tax provisions.  In conformity with the
federal tax provisions, Jacdisc received "bookkeeping" commissions
on international sales of products that were purchased from
Jacuzzi.  Both corporations have the same management, personnel,
facilities, and accounting operations.
     In 1980 and 1981 Jacuzzi and Jacdisc each filed separate
Arkansas income-tax returns.  In 1982 and 1983 the two corporations
filed combined returns and, at the same time, filed amended returns
for the years 1980 and 1981.  The amended returns were filed as
combined returns.  Neither corporation had requested or received
permission from the Commissioner to file combined returns.  The
Department disallowed the four combined returns on the ground that
Arkansas corporate income-tax law does not specifically require or
allow combined reporting and sent Jacuzzi a notice of proposed
assessment.  Jacuzzi countered with a claim for a refund and
pursued and exhausted its administrative remedies.  In an
administrative hearing that combined the assessment and claim for
refund, the administrative law judge ruled that the applicable
Arkansas income-tax statutes do not authorize combined reporting,
but that the Uniform Division of Income for Tax Purposes Act
(UDITPA) permits the Department to accept combined reporting.  The
administrative judge concluded that, although the Department could
accept combined reporting under UDITPA, the Department policy was
not to accept such returns; therefore, Jacuzzi was not entitled to
relief.
     Jacuzzi filed this suit in chancery court and asked that the
court order the Department to accept its income-tax returns on a
combined basis with Jacdisc and to decree that it was entitled to
the refunds.  The chancellor ruled that a combined return was
mandated in order to achieve a clear reflection of income and
expenses of the corporations and granted relief to Jacuzzi.       
The Department appeals.
     The Department's primary point of appeal is that the
chancellor erred in ruling that Arkansas law does not prohibit, but
rather requires, the filing of combined returns in order to achieve
a clear reflection of income.  Included within the primary point of
appeal are a number of subpoints.
     In the first of its subpoints the Department contends that the
chancellor erred in finding that its 1982 instruction booklet
provided for filing of combined returns.  The argument is well
taken.  The instruction booklet states that "DISC corporations are
treated as regular business corporations" and "Business
corporations, financial institutions, domestic insurance companies
and DISC corporations should use Ark. Form 1100 CT."  The booklet
thus indicates that the two corporations should each file a
separate return.
     In its second subpoint, the Department contends that the
chancellor erred in finding that the Department refused to allow
the four combined returns on ground that the corporations "had in
effect filed `consolidated' returns." This argument is also well
taken.  In refusing to allow the corporations to file the amended
combined returns, the Commissioner wrote that Arkansas statutes
authorize consolidated returns, but, "Arkansas Corporate Income Tax
Law does not specifically require or allow combined reporting. 
Therefore, the Revenue Division will not utilize unitary combined
reporting to tax multistate or multinational corporations.  Also,
the Revenue Division will not accept returns filed on a unitary
combined report basis."
     Consolidated reporting is based on the principle that a group
of corporations is taxed on their consolidated taxable income,
"representing principally the results of its dealings with the
outside world after the elimination of intercompany profit and
loss."  3 Boris I. Bittker & Lawrence Lokken, Federal Taxation of
Income, Estates, and Gifts  90.5 at 90 (2d ed. 1988).  Combined
reporting is distinguished from consolidated reporting as follows:
In a combined report ... the combined income of the
affiliated group is not computed for the purpose of
taxing such income, but rather as a basis for determining
the portion of income from the entire unitary business
attributable to sources within the state which is derived
by members of the group subject to the state's
jurisdiction.
Chesapeake Indus. v. Comptroller, 59 Md. App. 370, 376, 475 A.2d 1224, 1227 (1984) (quoting J. Buresh and M. Weinstein, Combined
Reporting: The Approach and Its Problems, 1 Jnl. of State Taxation
5 (1982)).  Or, as stated by the Oregon Supreme Court:
A combined report is an accounting method whereby each
member of a group carrying on a unitary business computes
its individual taxable income by taking a portion of the
combined net income of the group.  A consolidated return
is a taxing method whereby two corporations are treated
as one taxpayer.
Caterpillar Tractor Co. v. Department of Revenue, 289 Or. 895, 896,
618 P.2d 1261, 1262-63 (1980) (emphasis in the original).
     The chancellor ruled that combined returns are "mandated under
the present facts so as to achieve a clear reflection of income and
expenses of Jacdisc and Jacuzzi pursuant to Ark. Code Ann.  26-
51-805 (1987)." In its third subpoint the Department notes that the
cited statute involves consolidated corporate income tax returns;
consequently, it does not support the chancellor's ruling that the
statute "mandates" the filing of a combined return.  This argument
is also well taken as the statute does not "mandate" the filing of
a combined return or the filing of any specific type of return. 
The Department additionally notes that, contrary to the statute
supporting the filing of combined returns, the chancellor found
that "[t]he parties are in agreement that Ark. Code Ann.  26-51-
805 prohibits a DISC from filing `consolidated' income tax returns
with its parent corporation because the statute refers to federal
law relating to qualifications to file consolidated returns for
federal purposes."
     In its next subpoint, the Department argues that the
chancellor erred in ruling that Jacuzzi's filing of combined
returns was not prohibited by Uniform Division of Income for Tax
Purposes Act because Jacuzzi did not petition the Department for
permission to utilize the combined reporting method.  Before
discussing the details of this subpoint, it might be helpful to
state that there is no express provision in UDITPA, Ark. Code Ann.
 26-51-701--723, that requires or allows combined reporting. 
However, there is a discretionary provision in UDITPA upon which
combined reporting can be allowed and, in fact, is allowed by a
number of states.  That provision is section eighteen of the
Uniform Act, and the Arkansas Code carries forward the last two
figures of the numbering system, so that it is section 26-51-718. 
The section is as follows:
If the allocation and apportionment provisions of this
subchapter do not fairly represent the extent of the
taxpayer's business activity in this state, the taxpayer
may petition for or the Director of the Department of
Finance and Administration may require, in respect to all
or any part of the taxpayer's business activity, if
reasonable:
(a)Separate accounting;
(b)The exclusion of any one (1) or more of the factors;
(c)The inclusion of one (1) or more additional factors
which will fairly represent the taxpayer's business
activity in this state; or
(d) The employment of any other method to effectuate an 
 equitable allocation and apportionment of the taxpayer's
income.
     There is a split of authority among the states that have
adopted the UDITPA; some have not allowed the combined reporting,
while others have found that the discretionary provisions within
section eighteen of the UDITPA allow such reporting.  Jerome R.
Hellerstein, State Taxation  8.12[1] at 8-102 (1993).  The
administrative law judge found that the foregoing statute was
"permissive in terms of allowing a state to accept `combined
reporting.'"  We have never specifically addressed this issue, but
our holdings are consistent with the finding of the administrative
law judge.  See Pledger v. Illinois Tool Works, 306 Ark. 134, 812 S.W.2d 101 (1991) and Land O'Frost v. Pledger, 308 Ark. 208, 823 S.W.2d 887 (1992).
  In Caterpillar Tractor Co. v. Lenckos, 84 Ill. 2d 102,
417 N.E.2d 1343 (1981), the Illinois Supreme Court held:
     Considering whether UDITPA authorizes the use of
unitary apportionment, we first observe that UDITPA does
not make any reference to unitary apportionment or
combined reporting.  The absence of specific reference to
the unitary method is not, however, critical, for in a
number of jurisdictions that adopted UDITPA and in some
of them, the MTC as well, courts have held that unitary
apportionment or combined reporting was authorized though
the particular income tax statute made no reference to
this method of reporting.  In Coca Cola Co. v. Department
of Revenue (1975), 271 Or. 517, 533 P.2d 788, the Oregon
Department of Revenue applied a unitary or combined
apportionment method of accounting to the income tax
returns of the plaintiff corporation and its wholly owned
subsidiaries, which had filed separate returns using
Oregon's three-factor apportionment formula, which is
similar to that set out in the Illinois statute.  The
Department argued that the combined method, though not
specifically provided for in the tax statutes into which
UDITPA had been incorporated, would more accurately
reflect the income of what it contended was a unitary
business operation.  Concluding that the company's syrup
and bottling operations were so inextricably connected as
to constitute a unitary business, the court stated: "The
combined method of apportionment reporting is wholly
consistent with, and a natural extension of, the
apportionment method." (271 Or. 517, 528, 533 P.2d 788,
793.) The court held that the plaintiff and its
subsidiaries "are all part of the same unitary operation
and were required to use the combined method of reporting
for the tax years in question." 271 Or. 517, 529, 533 P.2d 788, 794.  See also American Smelting & Refining Co.
v. Idaho State Tax Com. (1979), 99 Idaho 924, 592 P.2d 39; Montana Department of Revenue v. American Smelting &
Refining Co. (1977), 173 Mont. 316, 567 P.2d 901.
The Supreme Court has also held that the absence of any
statutory reference to the unitary method of reporting
does not forbid its use.  In Butler Brothers v. McColgan
(1942), 315 U.S. 501, 62 S. Ct. 701, 86 L. Ed. 991, the
plaintiff, an Illinois corporation conducting a wholesale
goods an general merchandise business, was licensed to
conduct business in California.  The company had
wholesale distributing divisions located in seven states,
including California, each serving a district area and
each controlling its own sales force, accounting
procedures, sales operations and credit and financing
procedures as well.  Though the California tax statute
did not specifically authorize the combined method of
reporting or make any references to unitary operations,
the court upheld the State's decision to apply the
unitary method to the combined income derived from the
operations of the seven divisions.  In its holding the
court stated that "this court has recognized that unity
of the use and management of a business which is
scattered through several states may be considered when
a State attempts to impose a tax on an apportionment
basis.  As stated in Hans Rees' Sons, Inc. v. North
Carolina [(1931), 283 U.S. 123, 133, 51 S. Ct. 385, 389,
75 L. Ed. 879, 905], `the enterprise of a corporation
which manufactures and sells its manufactured product is
ordinarily a unitary business, and all the factors in
that enterprise are essential to the realization of
profits.'" 315 U.S. 501, 508, 62 S. Ct. 701, 704-05, 86 L. Ed. 991, 996.
     In a later case, Northwestern States Portland Cement
Co. v. Minnesota (1959), 358 U.S. 450, 79 S. Ct. 357, 3
L Ed. 421, the court addressed a similar challenge to the
use of a unitary apportionment method, and in citing Hans
Rees' and other apportionment decisions (e.g., Bass,
Ratcliff & Gretton, Ltd. v. State Tax Com. (1924), 266 U.S. 271, 45 S. Ct. 82, 69 L. Ed. 282; Underwood
Typewriter Co. v. Chamberlain (1920), 254 U.S. 113, 41 S. Ct. 45, 65 L. Ed. 165) the court upheld the use
declaring: "These cases stand for the doctrine that the
entire income of a corporation, generated by interstate
as well as intrastate activities, may be fairly
apportioned among the States for tax purposes by formulas
utilizing in-state aspects of interstate affairs."  358 U.S. 450, 460, 79 S. Ct. 357, 363, 3 L. Ed. 421, 428. 
See also Exxon Corp. v. Wisconsin Department of Revenue
(1980), 447 U.S. 207, 100 S. Ct. 2109, 65 L. Ed. 2d 66;
Mobil Oil Corp. v. Commissioner of Taxes (1980), 445 U.S. 425, 100 S. Ct. 1223, 63 L. Ed. 2d 510.
Id. at 118-20, 417 N.E.2d  at 1352-53.  Similarly, we hold that Ark.
Code Ann.  26-51-718 (1987) grants the Commissioner the
discretionary power to require or permit the apportionment on a
combined basis of the income of a taxpayer that is part of a
unitary business.
     Even so, Jacuzzi is not entitled to the relief granted by the
chancellor because it did not apply to the Commissioner to be
permitted to use this method of accounting in accordance with
section 26-51-718.  This evidence was clearly before the
chancellor.  The cross-examination of Charles Bellott, assistant
manager of the corporation income-tax section of the Department,
and a nineteen-year employee, is abstracted as follows:
I believe the Director can take into consideration
various factors in related companies in order to arrive
at a clear reflection of income.  A clear reflection of
income has a relationship to the activities within the
state.  Ark. Code Ann.  26-51-718 states something to
the effect that the inclusion of one or more additional
factors will fairly represent the business activity in
this State.  It says the Director or the Department may
consider those factors in the application of the
taxpayer.  It is the Department's goal to arrive at a
clear reflection of income.
On redirect, he testified as follows:
Ark. Code Ann.  26-51-718 deals with the allocation and
apportionment provisions of the UDITPA section.  A
taxpayer who wishes to deviate from the standard
formulary apportionment has to petition for a change. 
Jacuzzi has not petitioned for a change.  The Director
never authorized the deviation before the filing of the
returns.  Jacuzzi deviated without the Director's
permission from the formulary apportionment by filing
these returns.  That's an additional basis for rejecting
the returns.  A taxpayer cannot petition by filing a
return.  From my review of the returns, a petition to
utilize combined unitary reporting is not contained in
any of the returns.
     Jacuzzi counters that "[e]ven were such a petition required,
Jacuzzi's filing for refund using the combined method and filing
returns using the combined method certainly constitutes a
`petition' to employ the combined reporting method.  Any additional
procedure would be superfluous." Jacuzzi's response is not well
taken, as it would violate the separation of powers doctrine.
     The Department of Finance and Administration is a part of the
executive branch.  In a judicial review of the action of an
administrative agency of the executive department, a trial court
cannot, on appeal, substitute its judgment for that of the
executive department, but is restricted to considering whether, as
a matter of law, the agency acted fraudulently, arbitrarily, or
capriciously; whether the administrative action was substantially
supported by substantial evidence; and whether the agency's actions
were within the scope of its authority.  Here, the judicial branch
attempted to exercise the power of the executive branch.
     Reversed and remanded for proceedings consistent with this
opinion.
     Brown, J., concurring.

=================================================================

               Robert L. Brown, Justice, concurs.
     I concur with the conclusion in the majority opinion that the
Department of Finance and Administration must first address the
issue of combined reporting as it relates to Jacuzzi, Inc., and
Jacdisc, Inc., and this has not been done.  See Ark. Code Ann. 
26-51-718 (Repl. 1992).
     What concerns me is the following exchange that occurred
between justices of this court and counsel for the Department at
oral argument:
     COUNSEL FOR DEPARTMENT:  One final issue I'd like to
     address with the few seconds I have left is the issue of
     discretion.  That is the key to this case.  The director
     is vested with the discretion to use an alternative
     method should a taxpayer request an alternative method.
     JUSTICE BROWN: What factors would the director look to in
     determining whether combined reporting was appropriate or
     not?
     COUNSEL FOR DEPARTMENT: At this point, I do not believe
     that the director will allow combined reporting under any
     circumstances.
     JUSTICE BROWN: Well then discretion goes out--
     COUNSEL FOR DEPARTMENT:  It is discretionary and he
     cannot be forced to exercise that discretion by a
     taxpayer.
     JUSTICE BROWN:  But as far as if he is, if there has been
     a petition filed and he is in the process of determining
     whether combined reporting is appropriate or not, what
     factors would the director look to?
     COUNSEL FOR DEPARTMENT: Uh, whether or not it would
     equitably or more equitably allocate or apportion the
     income of the taxpayer.  But like I said earlier, the
     director does not allow combined reporting at present,
     and that is a discretionary matter with him.
     JUSTICE BROWN: So I mean, he's exercised his discretion
     by saying we're just not going to allow combined
     reporting under any circumstances.
     COUNSEL FOR DEPARTMENT:  Correct, your honor.  And with
     that, it gets back to the discretion, that it's within
     his discretion as to--
     JUSTICE GLAZE: Well that's no discretion at all, is it?
     COUNSEL FOR DEPARTMENT: Well, that is the exercise of
     discretion not to allow that.  It does come back to the
     same issue should someone, who wants, because they're
     asking for a refund here.  Of course they're gonna say
     this more accurately or equitably reflects their income. 
     They get a refund.  If it were on the--if the tables were
     turned and they owed taxes, it would be a different
     matter.  They wouldn't be here asking to file a combined
     return.  It would be a non-issue.  So, the same holds
     true with individual income tax.  They could possibly
     find another way to apportion their income when they have
     in-state and out-of-state income.  Individuals must
     report that out-of-state income--
     JUSTICE BROWN:  Well, if we sent this back for an
     appropriate petition to be filed for combined reporting,
     and for a hearing to be held, you're telling me that
     under no circumstances would the director authorize
     combined reporting?
     COUNSEL FOR DEPARTMENT: It is my understanding at this
     point that is correct, your honor. For combined
     reporting, it would not be allowed.
The only conclusion that can be reached from this colloquy is that
if Jacuzzi filed a petition for combined reporting, it would be a
vain and useless act.  We do not mandate exercises in futility.
     Our statutes provide that a taxpayer may petition the
Department for a more equitable allocation and apportionment of the
taxpayer's income related to the extent of the taxpayer's business
activity in this state, and that the Director of the Department
will consider the reasonableness of the request.  Ark. Code Ann. 
26-51-718 (Repl. 1992).  Thus, the Department cannot simply dismiss
all petitions for combined reporting out of hand.  It must consider
the relevant factors and exercise its discretion.  To do otherwise
violates  26-51-718 and would constitute arbitrariness in my
judgment.
     I concur in the majority opinion only because I conclude that
Department counsel is not the final word on the subject and because
I agree that the chancery court is limited to reviewing actions
taken by the Department.  In this case, the chancery court made the
initial decision to permit combined reporting and in doing so
exceeded the scope of its review.