Consolidated Rail Corp. v. Department of Revenue

December 9, 1997

1-96-1395

CONSOLIDATED RAIL CORPORATION; ) APPEAL FROM THE
PENNSYLVANIA TRUCK LINES, INC.; ) CIRCUIT COURT OF
and PTL INTERMODAL, INC., ) COOK COUNTY
)
Plaintiffs-Appellants, )
)
v. ) No. 94-L-50653
)
THE DEPARTMENT OF REVENUE, ) THE HONORABLE
) JOHN A. WARD,
Defendant-Appellee. ) JUDGE PRESIDING.


PRESIDING JUSTICE COUSINS delivered the opinion of the
court:
Plaintiff, Consolidated Rail Corporation (Conrail), appeals
from a determination of tax deficiency made by defendant, the
Department of Revenue, which disallowed Conrail from carrying
forward a $125 million Illinois net loss as a deduction.
Defendant based its denial upon the Conrail Privatization Act (45
U.S.C. 1301 et seq. (Supp. 1987)), a federal statute that
directed the public sale of the corporation and thereafter
treated Conrail as a new corporation for federal tax purposes,
thereby prohibiting Conrail from carrying forward its presale net
operating losses. The circuit court of Cook County upheld
defendant's determination. On appeal, plaintiff argues that the
circuit court erred in upholding defendant's disallowance on the
grounds that: (1) the "deemed sale" provisions of the federal
statute did not truly create a bona fide new corporation for
purposes of Illinois income tax law; and (2) net losses allowed
under Illinois law are not subject to the federal limitations on
federal net operating losses.
BACKGROUND
Conrail and its subsidiaries are engaged in the business of
hauling freight by rail primarily throughout 14 northeastern and
midwestern states. During the 1970s, seven railroads in those
regions went bankrupt, and Congress reacted to the potential
transportation crisis by passing the Regional Rail Reorganization
Act of 1973 (45 U.S.C. 701 et seq. (Supp. 1987)). This act
established the United States Railway Association (USRA) and
Conrail, a for-profit, quasi-governmental corporation. The USRA
had several directives, including deciding upon a final plan for
the transfer of the rail properties of the bankrupt railroads to
Conrail. Conrail, in turn, was responsible for receiving the
properties from the USRA and operating rail service thereon. In
1975, Congress accepted the USRA's final system plan,
incorporated Conrail as a Pennsylvania corporation, and commenced
operations in 1976, with the United States owning 85% of
Conrail's common stock and Conrail employees owning the remaining
15% through an employee stock ownership plan.
During its first seven years, Conrail proved to be highly
unprofitable, despite receiving billions of dollars of assistance
from Congress. The corporation declared enormous losses on its
federal income tax returns from 1976 through 1982, resulting in
an accumulated net operating loss of $2.2 billion during that
period. Congress once again reacted with support by passing the
Northeast Rail Service Act of 1981 (NERSA) (45 U.S.C. 1101 et
seq. (Supp. 1987)), which amended portions of the Regional Rail
Reorganization Act by exempting Conrail from liability for any
state taxes (45 U.S.C. 727(c) (Supp. 1987)) and requiring the
Secretary of Transportation to make arrangements for the sale of
the government's interest in Conrail (45 U.S.C. 761 (Supp. 1987)
(repealed 1986)). After NERSA was implemented, Conrail began to
improve and reported taxable income between $2 million and $314
million each year from 1983 through 1986.
In light of its $7 billion investment in Conrail and the
corporation's proven viability, Congress passed the Conrail
Privatization Act (CPA) in October 1986. 45 U.S.C. 1301 et seq.
(Supp. 1987). Under the CPA, the Secretary of Transportation was
to sell the United States' common stock in Conrail via a public
offering. 45 U.S.C. 1311, 1312 (Supp. 1987). The CPA also
provided for special tax treatment of the public sale of Conrail,
stating: "For periods after the public sale, for purposes of
Title 26, Conrail shall be treated as a new corporation which
purchased all of its assets as of the beginning of the day after
the date of the public sale for an amount equal to the deemed
purchase price." 45 U.S.C. 1347(a)(1) (Supp. 1987). The CPA
further provided that Conrail's exemption from state tax
liability would be extinguished with respect to taxable years
commencing after December 31, 1986. 45 U.S.C. 727(c) (Supp.
1987). The public offering was settled on April 2, 1987.
Since the CPA required Conrail to be treated as a new
corporation for purposes of the Internal Revenue Code, Conrail
filed a final "short year" federal income tax return for the
period January 1, 1987, through the settlement date of the public
sale, April 2, 1987 (April 2 federal return). The corporation
also filed an Illinois tax return for the same period (April 2
Illinois return). On the April 2 federal return, Conrail
reported a $2.9 billion loss for that period. This same loss was
reported on its April 2 Illinois return, which resulted in an
Illinois net loss of $125,022,130 based on that portion of
Conrail's operations conducted in Illinois.
In March of 1987, Conrail's board of directors adopted a
resolution establishing a new fiscal year ending April 30.
Consequently, the corporation filed another "short year" federal
return for the period April 3, 1987, through April 30, 1987
(April 30 federal return), as well as an Illinois return for that
period (April 30 Illinois return). Conrail declared a loss of
$46 million on the April 30 federal return, which resulted in an
apportioned Illinois net loss of $1,845,343 for the April 30
Illinois return. In addition, Conrail sought to carry forward
and report as part of its total Illinois net loss a portion of
the presale $125 million loss from its April 2 Illinois return.
For the period May 1, 1987, through April 30, 1988, Conrail
filed a federal return (1988 federal return) upon which the
corporation reported approximately $188 million in taxable
income. This same taxable income was declared on its 1988
Illinois return, which resulted in an Illinois base income of
approximately $7.2 million for that period. On that 1988
Illinois return, Conrail carried forward its Illinois net loss of
$1,845,343 from the previous April 30 Illinois return. In
addition, Conrail once again carried forward a portion of its
presale Illinois net loss of $125 million from the April 2
Illinois return. By setting off these deductions against its net
income, Conrail was able to reduce its Illinois net income to
zero and avoid any payment of taxes from its 1988 Illinois
return. Conrail achieved the same result from its 1989 Illinois
return, where it again carried forward its net losses from its
presale April 2 Illinois return and its April 30 Illinois return.
In 1990, the Department of Revenue (Department) audited
Conrail's postsale tax returns and concluded that, based on the
federal tax treatment of Conrail prohibiting any carryover of
presale net operating losses, the corporation would not be
allowed to carry forward its presale Illinois net loss of $125
million. The Department did, however, allow Conrail to carry
forward its postsale $1.8 million net loss from its April 30
Illinois return to offset income for 1988 (but not for 1989, as
the entire deduction was used in 1988). As a result, without the
carryover of Conrail's presale Illinois net loss, the Department
concluded that Conrail owed $1,276,679, consisting of $1,113,780
in unpaid taxes and $162,899 in penalties.
Conrail filed protests contesting the Department's notices
of deficiency, and an administrative hearing was held by the
Department in 1993. The administrative law judge issued a
recommendation for disposition stating that the Department's
conclusion should be followed and that the same bases for the
federal government's decision to prohibit Conrail from carrying
forward its presale federal net operating losses into postsale
tax years also applied to the context of Illinois net losses.
The Department, therefore, upheld its position, and Conrail filed
a complaint for administrative review in the circuit court. The
circuit court issued a memorandum decision and order affirming
the Department's conclusion on the merits but vacating its
decision as to the penalties. The Department followed the
circuit court's decision and imposed no penalties, after which
the court entered judgment in the Department's favor in March,
1996. Conrail now appeals the judgment of the circuit court.
We affirm.
ANALYSIS
We note that the parties present no factual disputes and
that only the legal issues presented are in controversy.
Consequently, this court is not bound by the administrative
agency's conclusions of law and statutory construction and will
review those decisions de novo. Raintree Health Care Center v.
Illinois Human Rights Comm., 173 Ill. 2d 469, 479 (1996); Thomas
M. Madden & Co. v. Department of Revenue, 272 Ill. App. 3d 212,
215, 651 N.E.2d 218, 220 (1995). We do, however, acknowledge the
deference that Illinois courts may give to administrative
agencies' interpretations and enforcement of statutes, as they
often have considerable experience and expertise in making
informed judgments upon the issues before them. Bonaguro v.
County Officers Electoral Board, 158 Ill. 2d 391, 398 (1994),
citing Abrahamson v. Illinois Department of Professional
Regulation, 153 Ill. 2d 76, 97-98 (1992).
I
Plaintiff first contends that the Conrail Privatization Act
did not factually or legally create a new corporation for all
purposes. Plaintiff argues that the administrative law judge and
the circuit court took the legal fiction of an "old" and "new"
Conrail--a concept established in the "deemed sale" provisions of
the CPA for federal tax purposes--and erroneously applied that
fiction to Illinois income tax law. Plaintiff concedes that the
tax treatment provision of the CPA has barred Conrail from
carrying forward any of its federal net operating losses from tax
years preceding the sale. Plaintiff insists, however, that any
such prohibition on carryovers is limited exclusively to the
federal tax realm and argues that, since Conrail has, in reality,
undergone only trivial corporate change, this reveals that the
fiction of an "old" and "new" Conrail was created only to
facilitate the federal directives delineated in the CPA.
In support of this position, plaintiff states that the only
significant change that occurred to Conrail was the transfer of
ownership of 85% of the corporation's stock. Plaintiff contends
that this shift in ownership had no effect upon the continued
success of the corporation and that Conrail remained the same
business with the same rail properties, employees, corporate
charter, articles of incorporation, and tax identification
number. Plaintiff's assertion, however, is not entirely
accurate. The CPA called for a number of important changes to
Conrail, including the termination of the USRA, the cancellation
of all of Conrail's governmental liabilities, as well as the
gradual replacement of its board of directors. Furthermore,
Conrail's articles of incorporation were amended to reflect,
among other things, new restrictions on capital expenditures,
ownership, and the corporation's fundamental purpose.
Plaintiff's argument for separate tax treatment in Illinois
based on the reality that Conrail remained the same corporation
is ultimately deflated by the language of the CPA; language which
reveals that Congress was fully aware that Conrail would remain
essentially the same corporation. By providing that, "for
purposes of [federal taxation], Conrail shall be treated as a new
corporation" after the public sale, Congress implicitly
acknowledged that it was not, in fact, creating a new entity.
(Emphasis added.) 45 U.S.C. 1347(a)(1) (Supp. 1987). Indeed,
the creation of section 1347(a)(1) shows that, while the
government wanted Conrail to continue its operations as before,
Congress expressly intended for the corporation to receive new
tax treatment. This is supported by the various provisions of
the CPA affecting a major reconstitution of the corporation's
financial attributes; in particular, Congress' decision to treat
the sale of stock as a sale of assets in accordance with an
election under section 338 of the Internal Revenue Code, and its
decision to allow a significant reduction in the book value of
the "new" Conrail from that of the "old" Conrail. These measures
undoubtedly were taken to ensure that Conrail would be
financially independent of the federal government. Further proof
of Congress' intent to give sweeping new tax treatment to Conrail
is found in the temporary federal regulations promulgated by the
Treasury Department pursuant to the CPA, which make a fundamental
distinction between the "old" and "new" Conrail: "The term new
Conrail means Conrail, on the purchase date and for all periods
thereafter. New Conrail shall be treated as unrelated to old
Conrail for all purposes." (Emphasis added.) Temp. Treas. Reg.
18.0 (1987). Consequently, we hold that plaintiff's focus on
dismantling the fiction of an "old" and "new" Conrail is an
unpersuasive basis for arguing that Conrail should be allowed to
carry forward its presale Illinois net losses.
II
Plaintiff also contends that the CPA's tax treatment of
Conrail does not apply to the Illinois tax regime on the grounds
that a particular provision under Illinois law prevails over the
federal statute. Specifically, plaintiff relies on section 207
of the Illinois Income Tax Act (35 ILCS 5/101 et seq. (West
1992)), which provides for the carryover deduction of a
taxpayer's Illinois net losses. Section 207 states, in pertinent
part: "If after applying all of the modifications provided for
in paragraph (2) of Section 203(b) ***, the taxpayer's net income
results in a loss, such loss shall be allowed as a carryover or
carryback deduction in the manner allowed under Section 172 of
the Internal Revenue Code." 35 ILCS 5/207(a) (West 1992).
Plaintiff reads this provision as being silent on the issue of
whether federal limitations on net operating losses apply to
Illinois net losses. Plaintiff further argues that, since there
is a difference between the computation of federal net operating
losses and Illinois net losses, the allowance for carryover of
Illinois net losses is unaffected by federal limitations on net
operating loss carryovers.
Plaintiff attempts to support its position by referring to
the Department's own regulations concerning Illinois net loss
computations. As plaintiff points out, Regulation 100.2300(b)
differentiates between "Illinois net loss" and federal "net
operating loss." 86 Ill. Adm. Code 100.2300(b) (1996).
Plaintiff further illustrates that the computation of Illinois
net losses is fundamentally different from that of federal net
operating losses, which is evidenced by the fact that a taxpayer
is capable of taking an Illinois net loss deduction despite not
having a federal net operating loss for the same tax period. In
addition, plaintiff makes reference to an issue of the
Department's own newsletter, Taxation Today, which characterized
section 207 as having "decoupled" the Illinois Income Tax Act
from the Internal Revenue Code with respect to the computation of
Illinois net losses. Taxation Today, Dept. of Rev. Newsltr., par.
400-236, at 22,430-32 (C.C.H.) (Spring 1987).
We believe, however, that plaintiff's argument based on
section 207 is specious. We agree with the administrative law
judge's conclusion that a line of reasoning grounded in section
207 is irrelevant to the central issue of whether plaintiff
should be allowed to carry forward its presale Illinois net
losses. Indeed, we find that section 207 speaks to the issue of
computation of net losses and does not bring any clarity to the
relevant question at bar: whether a "new" corporation, which
purchased all of its predecessor's assets whose net operating
losses were nullified for federal taxation purposes, can carry
forward those losses for purposes of Illinois taxation.
Therefore, we do not find it necessary to analyze the extent to
which section 207 mirrors or differs from federal tax laws, for
even if section 207 were found to be genuinely independent from
the Internal Revenue Code, such a conclusion would only go to the
issue of the manner in which Illinois net losses are calculated.
Instead, we choose to focus on the propriety of the
Department's decision to follow the mandate of the CPA in light
of the absence of Illinois legislation concerning the tax
treatment of Conrail. Since the Illinois General Assembly passed
no special legislation to conform with the CPA, and Congress
drafted the federal statute in terms of federal tax treatment of
Conrail, the Department arguably had no binding statute upon
which to base its decision to deny plaintiff's presale Illinois
net loss carryover. We note, however, that the Department did
not need special statutory authority to render its decision. We
believe, therefore, that, in the absence of clear statutory
authority, reference to the legislative history of the CPA is
proper. See In re B.C., 176 Ill. 2d 536, 542-43 (1997) (where the
meaning of a statute is unclear from the statutory language
itself, the court may look beyond the language and consider the
purpose of the law, the evils the law was designed to remedy, and
legislative history to discern legislative intent); see also
People v. Jameson, 162 Ill. 2d 282, 288 (1994).
One example that further illustrates Congress' intent to
divorce Conrail from further government subsidies and place it on
the tax rolls of the states in which it operates is found in the
congressional reports preceding the CPA's enactment, which state,
in part:
"Conrail will be treated as a new corporation that
purchased the assets after the public sale. Thus, the
aggregate basis for Conrail's assets will be adjusted
to reflect the stock purchase price (plus liabilities
and other relevant items). Similarly, no NOL or other
carryovers from periods before the public sale will be
available for use in postsale periods." (Emphasis
added.) H.R. Conf. Rep. No. 99-1012, at 373 (1986),
reprinted in 1986 U.S.C.C.A.N. 3868, 4018.
While we do not propose that the words "no NOL or other
carryovers" necessarily include Illinois net loss carryovers, we
believe that they do reveal the importance that Congress placed
on making clear that Conrail was no longer to benefit from or
perpetuate its previous tax attributes.
Indeed, our assessment of the congressional intent behind
the CPA reveals that the federal government intended for Conrail
to fully achieve the status of a private corporation, free of
government control and special tax benefits. Plaintiff's
position, on the other hand, calls for us to allow the private,
"new" Conrail to enjoy tax benefits that are unavailable to other
private corporations conducting business in Illinois. We agree
with the circuit court's point that, "[h]ad Congress expressly
declared the dissolution of the Old Conrail at the time of the
sale, and the simultaneous creation of the New Conrail, without
doubt, that new entity would not succeed to the presale operating
losses for purposes of federal or state taxation." Consolidated
R. Corp. v. Department of Revenue, No. 94-L-50653, Memorandum
Dec. and Order at 13 (March 22, 1996). Congress' privatization
of Conrail essentially by means of an election under section 338
of the Internal Revenue Code was no less legitimate than an
actual, simultaneous corporate dissolution and formation. The
fact that Congress terminated plaintiff's exemption from state
tax liability after the public sale and provided for special tax
treatment in the CPA to bring Conrail in line with a truly
private corporation's tax attributes further supports our
conclusion that the Department's treatment of Conrail was proper.
This decision is supported not only by the aforementioned
congressional authority, but by relevant portions of the Illinois
Income Tax Act itself. Section 401(a) states that "[f]or
purposes of the tax imposed by this Act, the taxable year of a
person shall be the same as the taxable year of such person for
federal income tax purposes." 35 ILCS 5/401(a) (West 1992). In
the case at bar, plaintiff filed a "final" April 2 federal return
in recognition of the fact that the CPA created an "old" and
"new" Conrail as of April 2, 1987. Likewise, plaintiff
designated its April 30 federal tax return as its "initial
return," consistent with the notion that Conrail had taken on new
tax attributes as of the settlement date of the public sale.
When viewed in light of section 401(a), we find that plaintiff
was not free to disregard its federal designations of "final" and
"initial" returns in the context of Illinois taxation. That is,
we read section 401(a) to mean that, when one files a federal
return for a certain period, the taxpayer's Illinois return must
be filed for a period that is consistent with any designations
made pursuant to federal law.
Further support of the Department's decision is found in
section 403(a) of the Illinois Income Tax Act, which states:
"To the extent not inconsistent with the
provisions of this Act ***, each person making a return
under this Act shall take into account the items of
income, deduction and exclusion on such return in the
same manner and amounts as reflected in such person's
federal income tax return for the same taxable year."
(Emphasis added.) 35 ILCS 5/403(a) (West 1992).
We believe that section 403(a) not only reveals the Illinois
legislature's intention that Illinois tax law generally coincide
with the Internal Revenue Code, but it also supports the
conclusion that an Illinois taxpayer must retain the same tax
attributes used in claiming federal deductions when claiming
similar deductions on its Illinois returns. A contrary result
would mean that a taxpayer could assume one identity with certain
traits for federal purposes and assume another identity with
drastically different tax attributes for Illinois tax purposes.
Such a practice, however, would contravene both the general
spirit and express language of the Illinois Income Tax Act. We
find, therefore, that the federal characterization of Conrail as
being a "new" corporation for tax purposes--thereby prohibiting
it from carrying over presale net losses--applies in the context
of Illinois taxation.
We also note that the allowance of a deduction for net
losses is a privilege created by statute as a matter of
legislative benevolence. Bodine Electric Co. v. Allphin, 81 Ill. 2d 502, 512-13 (1980), aff'g 70 Ill. App. 3d 844, 850, 389 N.E.2d 168, 173 (1979), citing United States v. Olympic Radio &
Television, Inc., 349 U.S. 232, 235, 99 L. Ed. 1024, 1028, 75 S. Ct. 733, 736 (1955). As a consequence, Illinois courts have
determined that issues concerning deductions are to be strictly
construed in favor of taxation. Chen v. Department of Revenue,
196 Ill. App. 3d 583, 589, 554 N.E.2d 428, 431-32 (1990), citing
Balla v. Department of Revenue, 96 Ill. App. 3d 293, 295, 421 N.E.2d 236, 238 (1981). Likewise, Illinois courts have
established that a taxpayer is not entitled to a deduction absent
a showing that the deduction is clearly allowed by statute, the
burden of such a showing resting upon the taxpayer. Bodine, 81 Ill. 2d at 513; Chen, 196 Ill. App. 3d at 589, 554 N.E.2d at 431.
We are not convinced that plaintiff has met this burden in the
case at bar, as plaintiff cites no authority which supports its
position that, following a fundamental corporate change pursuant
to a section 338 election, an entity is allowed to succeed to or
retain certain tax attributes, such as net losses, for state
purposes when such characteristics are patently extinguished for
purposes of federal taxation.
Accordingly, we affirm the decision of the circuit court.
Affirmed.
CAHILL and LEAVITT, JJ., concur.