Borden, Inc. v. Dept. of Revenue

FIFTH DIVISION
March 27, 1998

No. 1-96-2408

BORDEN, INC., ) Appeal from the
) Circuit Court of
Plaintiff-Appellant, ) Cook County.
)
v. )
) No. 92 L 50493
THE ILLINOIS DEPARTMENT OF )
REVENUE and DOUGLAS H. WHITLEY, ) The Honorable
) John A. Ward,
Defendants-Appellees. ) Judge, Presiding.

JUSTICE HOURIHANE delivered the opinion of the court:
Plaintiff, Borden, Inc. (Borden), appeals an order of the
circuit court affirming a decision of the Director of the Illinois
Department of Revenue (Director). The Director found that, for
purposes of the Illinois Income Tax Act (Tax Act) (Ill. Rev. Stat.
1981, ch. 120, par. 1-101 et seq. (now 35 ILCS 5/101 et seq. (West
1996))), Borden's three Pepsi-Cola subsidiaries (Pepsi Subs) were
part of Borden's "unitary business group" and the capital gains
Borden realized from the sale of its Pepsi Subs stock in 1982 was
"business income". We affirm.
BACKGROUND
Borden, a New Jersey corporation with its principal place of
business in New York, is engaged in the manufacture and marketing
of food, consumer, and chemical products and in the provision of
related services. Borden operates in various states, including
Illinois. In 1971, Borden acquired the Pepsi Subs as wholly owned
subsidiaries.[fn1] The Pepsi Subs are independent bottlers which
operate within designated geographical areas under exclusive
bottling and syrup appointments with Pepsi-Cola Corporation
(Pepsi), a Delaware corporation. The bottling and syrup
appointments prohibit the Pepsi Subs from distributing any other
"cola" and require the Pepsi Subs' participation in various
advertising and promotional programs.
In January 1982, Borden sold the Pepsi Subs stock and realized
a long-term capital gain in excess of $27,000,000. During the
course of a subsequent tax audit, Borden advised the Department
that Borden had incorrectly included the capital gain in its
business income, rather than in its non-business income, and filed
a valid claim for refund. Following the audit, Borden filed a
Protest and Hearing Request, contesting the Department's
determination that, for each of tax years 1981 and 1982, Borden and
the Pepsi Subs were engaged in a unitary business operation, and
that the gain realized by Borden on the sale of the Pepsi Subs
stock was business income.
The administrative law judge (ALJ) found that Borden and the
Pepsi Subs were not engaged in a unitary business and that the gain
on the sale of the stock was business income. The Director
rejected the recommended decision of the ALJ that Borden and the
Pepsi Subs did not conduct a unitary business, but concurred with
the ALJ as to the inclusion of the capital gain as business income.
Borden subsequently filed a complaint for administrative review.
The circuit court found the Director's decision was not against the
manifest weight of the evidence and affirmed the Director's
decision in full. This appeal followed. 735 ILCS 5/3-112 (West
1996); 155 Ill 2d R. 301.
ANALYSIS
Unitary Business Group
Where a corporate taxpayer operates in more than one state,
the amount of income fairly attributable to the taxing state must
be determined before income tax may be constitutionally imposed.
General Telephone Co. of Illinois v. Johnson, 103 Ill. 2d 363, 368,
469 N.E.2d 1067 (1984). If the taxpayer owns and operates two
distinct businesses located in different states, the taxpayer can
account separately for the income of each business and accurately
allocate income to the taxing states. However, where a corporate
taxpayer conducts a single, functionally integrated business in
several states, i.e., a unitary business, separate accounting will
likely be insufficient to apportion income among the various taxing
states. Thus, many states, including Illinois, have developed
formulas for apportioning income to their state from unitary
businesses. Citizens Utilities Co. v. Department of Revenue, 111 Ill. 2d 32, 39-40, 488 N.E.2d 984 (1986); General Telephone Co.,
103 Ill. 2d at 369; 35 ILCS 5/304(a) (West 1996).
A corporate taxpayer may also be a member of a unitary
business group--"a closely associated group of corporations that
collectively engages in a multistate unitary business". General
Telephone Co., 103 Ill. 2d at 371. Where a part of the group's
business is conducted in Illinois, a "combined apportionment"
method is used to determine the business income attributable to
this state by any member of the group. General Telephone Co., 103
Ill. 2d at 370-71; 35 ILCS 5/304(e) (West 1996). Borden does not
challenge the methodology for apportioning income. Rather, Borden
appeals the Director's determination that the Pepsi Subs were part
of Borden's unitary business group for tax years 1981 and 1982.
Generally, whether a taxpayer participated in a unitary
business group is a question of fact for the Department to
determine, which will not be reversed on review unless against the
manifest weight of the evidence. Citizens Utilities Co., 111 Ill. 2d at 47. Here, however, the facts were not in dispute. The case
proceeded before the ALJ upon 93 stipulated facts and 41 joint
exhibits. The legal effect to be given to these undisputed facts
is a matter of law (American National Bank & Trust Co. v.
Department of Revenue, 242 Ill. App. 3d 716, 721, 611 N.E.2d 32
(1993)), and this court is not bound by the agency's or the circuit
court's legal conclusions (Obasi v. Department of Professional
Regulation, 266 Ill. App. 3d 693, 699, 639 N.E.2d 1318 (1994);
Kroger Co. v. Department of Revenue, 284 Ill. App. 3d 473, 482, 673 N.E.2d 710 (1996)). Under such circumstances, the proper standard
of review is not the manifest weight of the evidence test, but
whether the agency's decision is arbitrary, unreasonable and not
supported by sufficient evidence. Obasi, 266 Ill. App. 3d at 699.
With respect to tax year 1981, no statutory definition of
"unitary business group" had yet been adopted by our legislature.
However, combined apportionment was required for such groups.
Caterpillar Tractor Co. v. Lenckos, 84 Ill. 2d 102, 417 N.E.2d 1343
(1981). In Caterpillar Tractor Co., our supreme court described a
unitary business as follows:
"A unitary business operation is one in which there
is a high degree of interrelationship and
interdependence between, typically, one corporation,
which generally is a parent corporation, and its
corporate subsidiaries or otherwise associated
corporations, which group is usually engaged in
multistate, and in some cases in international
business operations. Because of this integrated
relationship, which is reflected in all phases of
the business operations, it is extremely difficult,
for purposes of taxation, to determine accurately
the measure of taxable income generated within a
State by an individual corporation of the unitary
group which is conducting business in the State.
Typically, the corporation's transactions and the
income derived from them actually represent the
business efforts of the individual corporation, plus
efforts of other and possibly all members of the
unitary business operation. As a result, the
claimed income of each member of the group standing
alone does not, in a real sense, reflect the
conducting of a unitary business operation because
the income is not attributable solely to the effort
of the particular corporation." Caterpillar Tractor
Co., 84 Ill. 2d at 108.
The Department also promulgated a regulation, effective
December 29, 1981, which describes a "unitary business" as follows:
"A trade or business carried on by more than one
person is unitary in nature when the persons are
related through common ownership and when the trade
or business activities of each of the persons are
integrated with, dependent upon, or contribute to
the activities of one or more of the other persons."
6 Ill. Reg. 579 (now 86 Ill. Adm. Code 100.3010
c)1) (1996)).
The regulation also lists three factors, the presence of any one of
which creates a strong indication that the activities of the
taxpayers constitute a unitary business: (1) when all of the
activities are in the same general line; (2) when the activities
are steps in a vertical process; and (3) when there is a strong
central management. 86 Ill. Adm. Code 100.3010 c)1)A),B),C)
(1996).
The Department's definition of unitary business is similar,
but not identical, to the statutory definition which became
effective December 15, 1982, for tax years ending on or after
December 31, 1982 (see P.A. 82-1029). The statutory definition
reads in relevant part:
"The term 'unitary business group' means a
group of persons related through common ownership
whose business activities are integrated with,
dependent upon and contribute to each other. ***
Unitary business activity can normally be
illustrated where the activities of the members are:
(1) in the same general line (such as manufacturing,
wholesaling, retailing of tangible personal
property, insurance, transportation or finance); or
(2) are steps in a vertically structured enterprise
or process (such as the steps involved in the
production of natural resources, which might include
exploration, mining, refining, and marketing); and,
in either instance, the members are functionally
integrated through the exercise of strong
centralized management (where, for example,
authority over such matters as purchasing,
financing, tax compliance, product line, personnel,
marketing and capital investment is not left to each
member)." Ill. Rev. Stat. 1983, ch. 120, par. 15-
1501(a)(28) (now 35 ILCS 5/1501 (a)(27) (West
1996)).
On appeal, Borden contends that the threshold for unitary
treatment--functional integration--has not been crossed, and that
given the restrictive nature of the bottling agreements between the
Pepsi Subs and Pepsi, no such integration could have taken place.
We disagree.
In support of its conclusion that Borden and the Pepsi Subs
were functionally integrated, the Director cited the following
stipulated facts:
"1. The Pepsi-Subs were members of the Dairy and
Services Division of Borden's food segment which
included other Borden subsidiaries; in October,
1980, Borden reorganized various divisions and the
Pepsi-Subs became a part of the Specialty Products
Group of Borden's Consumer [P]roducts Division.
2. Borden's Internal Audit Department monitored
the activities and accounting procedures of Borden's
subsidiaries, including the Pepsi-Subs;
3. Borden's Controller managed and oversaw the
accounting functions of all Borden subsidiaries
including the Pepsi-Subs. The Pepsi-Subs used the
same outside accounting firm that Borden used.
Borden managed the way the Pepsi-Subs reported their
financial data to Borden to facilitate the
preparation of consolidated financial reports.
4. Borden's Tax Department prepared tax returns
for the Pepsi-Subs.
5. All of Borden's subsidiaries, including the
Pepsi-Subs, participated in a centralized cash
management system that was controlled by Borden's
Treasurer;
6. Borden's Employee Relations and Legal
Departments provides services to all of the Borden
subsidiaries, including the Pepsi-Subs;
7. Borden's [I]nsurance Department administered
various insurance program[s] for all of Borden's
domestic subsidiaries, including the Pepsi-Subs;
8. Borden's Employee Benefits Department
administered employee benefit programs for Borden's
domestic subsidiaries, including the Pepsi-Subs;
9. The Pepsi-Subs participated in Borden's
minority purchasing program and were required to
follow Borden's affirmative action program and
television advertising policy.
10. Borden approved the Pepsi-Subs' operating
budget and capital expenditures.
11. Borden appointed the officers of the Pepsi-
Subs;
12. Borden determined the compensation and benefit
packages for the officers of the Pepsi-Subs;
13. Two officers of the Pepsi-Subs later became
officers of a Borden division. One of these
officers approved the budgets and capital
expenditures of the Pepsi-Subs;
14. The centralized services provided to the Borden
subsidiaries were provided at cost or without
charge[.]"
These facts demonstrate that Borden treated the Pepsi Subs as
it did its other subsidiaries, which Borden conceded were part of
its unitary business. Further, the Tax Act states that functional
integration is demonstrated "where, for example, authority over
such matters as purchasing, financing, tax compliance, product
line, personnel, marketing and capital investment is not left to
each member". Ill. Rev. Stat. 1983, ch. 120, par. 15-1501(a)(28)
(now 35 ILCS 5/1501(a)(27) (West 1996)). The stipulated facts make
clear that Borden retained control over financing, tax compliance,
and at least some aspects of purchasing, personnel, and marketing.
Thus, we cannot accept Borden's conclusion that the Pepsi Subs were
autonomous. We find Citizens Utilities Co., on which the
Department relies, instructive.
In Citizens Utilities Co., our supreme court considered
whether the corporate taxpayer was part of the parent corporation's
unitary business. The taxpayer was a wholly owned subsidiary of
the parent, which controlled 24 similar corporations. The taxpayer
was the only subsidiary which operated solely in Illinois. With
few exceptions, the parent and the subsidiaries shared the same
officers as well as interlocking boards of directors. The parent
specifically approved all expenditures by the subsidiaries in
excess of a certain amount, reviewed major engineering projects,
and provided legal assistance and complex accounting functions
(including preparation of tax returns), at cost. Revenues
deposited by the taxpayer could be withdrawn by the parent at any
time, thus providing a vehicle for making interest-free loans for
investment in another subsidiary. Based on the foregoing evidence,
the court concluded that the hearing officer's determination that
the taxpayer was part of the parent's unitary business was not
against the manifest weight of the evidence.
Many of the factors which our supreme court found dispositive
in Citizens Utilities Co. are present here, and although Citizens
Utilities Co. involved tax years pre-1981, the court's rationale is
sound under both the 1981 departmental regulation and section 1501
of the Tax Act. It is also consistent with United States Supreme
Court precedent which generally looks to three objective factors as
indicative of a unitary business: functional integration,
centralization of management, and economies of scale. See Allied-
Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 781-
83, 119 L. Ed. 2d 533, 112 S. Ct. 2251 (1992) and cases cited
therein.
Citing F.W. Woolworth Co. v. Taxation and Revenue Department
of the State of New Mexico, 458 U.S. 354, 73 L. Ed. 2d 819, 102 S. Ct. 3128 (1982), Borden further argues that the Director's finding
that Borden "could" exercise influence over the activities of the
Pepsi Subs falls short of the requirement that Borden exercise
"actual" control over centralized functions. In F.W. Woolworth
Co., the United States Supreme Court held that the mere potential
of the parent corporation to operate its subsidiaries as integrated
divisions of a unitary business was insignificant if, in fact, the
subsidiaries comprised discrete business operations.
The evidence in that case demonstrated that, despite the
potential for control, no phase of any subsidiary's business was
integrated with the parent's business. Site selection of new
stores, merchandise selection, advertising, and accounting were
performed by each subsidiary independently of the parent company.
Each subsidiary also had a complete accounting department and
financial staff. There was no centralized purchasing,
manufacturing, or warehousing of merchandise, and little overlap of
officers. Further, each subsidiary possessed autonomy to determine
its own retailing policies. That is not the case here.
Further, the Director's decision states that "strong
centralized management existed between Borden and [the] Pepsi-
Subs", and that the "stipulated record demonstrates a high degree
of centralization of functions". The Director also stated that
"the exercise of strong centralized management shows that
functional integration exists between Borden[] and [the] Pepsi-
Subs." The sufficiency of such findings is clear, particularly in
light of this court's recent decision in A.B. Dick Co. v. McGraw,
287 Ill. App. 3d 230, 678 N.E.2d 1100 (1997).
In A.B. Dick, this court rejected the notion that functional
integration is a separate concept from centralized management and
held that "[w]henever there is functional integration of operations
there is also strong centralized management and vice versa." A.B.
Dick, 287 Ill. App. 3d at 233. If one or the other other has been
shown, then there is a unitary business. A.B. Dick, 287 Ill. App.
3d at 233. The stipulated facts here demonstrate a strong
centralized management and, accordingly, that functional
integration has occurred. That the Director also stated that
Borden "could" exert great influence over the Pepsi Subs does not
detract from the substance of the decision. In any event, the
issue of whether the parent possessed the potential for control has
been found relevant to, although not dispositive of, the existence
of a unitary business. See Container Corp. of America v. Franchise
Tax Board, 463 U.S. 159, 177 n.16, 77 L. Ed. 2d 545, 103 S. Ct. 2933 (1983).
In light of the foregoing, it cannot be said that the
Director's decision is arbitrary, unreasonable, and not supported
by sufficient evidence. Obasi, 266 Ill. App. 3d at 699.
Accordingly, the circuit court's order affirming the Director's
decision as to the existence of a unitary business is affirmed.
Business v. Non-Business Income
Borden next challenges the Department's determination that the
capital gains from the sale of the Pepsi Subs stock was "business
income". Under the Tax Act, where a taxpayer derives its business
income from this state and one or more other states, such income is
subject to "apportionment", i.e., using the statutory formula, the
income is apportioned among the various jurisdictions in which the
taxpayer conducts his business. Ill. Rev. Stat. 1981, ch. 120,
par. 3-304(a) (now 35 ILCS 5/304(a) (West 1996)); National Realty &
Investment Co. v. Department of Revenue, 144 Ill. App. 3d 541, 553,
494 N.E.2d 924 (1986).
"Non-business income", on the other hand, is subject to
"allocation", i.e., non-business income is assigned in its entirety
to a particular taxing jurisdiction based on certain statutory
criteria, such as the situs of the property. Ill. Rev. Stat. 1981,
ch. 120, par. 3-303 (now 35 ILCS 5/303 (West 1996)); National
Realty, 144 Ill. App. 3d at 553.
"Business income" is defined under the Tax Act in pertinent
part as:
"[I]ncome arising from transactions and
activity in the regular course of the taxpayer's
trade or business *** and includes income from
tangible and intangible property if the acquisition,
management and disposition of the property
constitute integral parts of the taxpayer's regular
trade or business operations." Ill. Rev. Stat.
1981, ch. 120, par. 15-1501(a)(1) (now 35 ILCS
5/1501(a)(1) (West 1996)).
"Non-business income" is defined as "all income other than business
income or compensation." Ill. Rev. Stat. 1981, ch. 120, par.
1501(a)(13) (now 35 ILCS 5/1501(a)(13) (West 1996)). A taxpayer's
income is business income unless it is clearly classifiable as non-
business income. Kroger Co., 284 Ill. App. 3d at 479; 86 Ill. Adm.
Code 100.3010 a) (1996).
Illinois courts have construed section 1501(a)(1) of the Tax
Act as embodying both a "transactional" test and a "functional"
test to determine whether income is business income. Kroger Co.,
284 Ill. App. 3d at 479-80; Dover Corp. v. Department of Revenue,
271 Ill. App. 3d 700, 711, 648 N.E.2d 1089 (1995); National Realty,
144 Ill. App. 3d at 554-55. "If either test is met, the income
constitutes business income." Dover Corp., 271 Ill. App. 3d at
711; National Realty, 144 Ill. App. 3d at 554.
Under the transactional test (derived from the first clause of
section 1501(a)(1)), if the income results from a business
transaction in which the taxpayer regularly engages, it is business
income. Dover Corp., 271 Ill. App. 3d at 711. Under the
functional test (derived from the second clause of section
1501(a)(1)), the relevant inquiry is whether the property was used
in the taxpayer's regular trade or business operations. Dover
Corp., 271 Ill. App. 3d at 712.
The ALJ determined that the transactional test was met.
Referring to Borden's own annual reports, the ALJ noted that at the
time the stock was sold, Borden was undergoing a massive
restructuring, and that part of this plan involved a redeployment
of assets under which certain companies, including the Pepsi Subs,
were sold. The proceeds were utilized to help fund a $1.5 billion
capital investment program which would run through 1985. The ALJ
concluded, and the Director agreed, that the sale of the Pepsi Subs
was part of an overall corporate plan to expand and consolidate
Borden's unitary business, and that the acquisition, management and
disposition of the Pepsi Subs stock constituted integral parts of
Borden's regular trade or business. The circuit court affirmed.
Although no Illinois case is directly on point, the
Department's regulations shed some light on the difference between
business versus non-business income. For example, with respect to
gains or losses from sales of assets, where a corporation
constructed a plant for use in its multistate manufacturing
business and 20 years later sold the property at a gain while it
was in operation by the corporation, the gain is business income.
86 Ill. Adm. Code 100.3010 d)3)B)(1996). With respect to
dividends, where a corporation is engaged in a multistate
manufacturing business and also holds a portfolio of stock and
interest-bearing securities, the acquisition and holding of which
are unrelated to the corporation's trade or business operations,
the dividends and interest income received are nonbusiness income.
86 Ill. Adm. Code 100.3010 d)5)F) (1996).
The Pepsi Subs stock was not held as part of a portfolio of
stocks which was unrelated to Borden's multistate business.
Further, in light of Borden's restructuring and massive capital
investment program, it cannot be said that income from the sale of
the stock is so removed from Borden's trade or business as to be
"clearly classifiable as non-business income." Kroger, 248 Ill.
App. 3d at 479.
Finally, Borden argues that the circuit court's decision
finding that the functional test had been met renders meaningless
any distinction between business and non-business income. In
support of its position, Borden cites ASARCO, Inc. v. Idaho State
Tax Comm'n, 458 U.S. 307, 73 L. Ed. 2d 787, 102 S. Ct. 3103 (1982).
In ASARCO, the United States Supreme Court rejected the Idaho
Tax Commission's assertion that income from intangible property
should be considered part of a unitary business when the
intangibles "contribute to or relate to or are some way in
furtherance of the taxpayer's own trade or business". ASARCO, 458 U.S. at 326. The court explained:
"The business of a corporation requires that it
earn money to continue operations and to
provide a return on its invested capital.
Consequently all of its operations, including
any investment made, in some sense can be said
to be 'for purposes related to or contributing
to the [corporation's] business.' When pressed
to its logical limit, this conception of the
'unitary business' limitation becomes no
limitation at all." (Emphasis original.)
ASARCO, 458 U.S. at 326.
We need not resort to the expansive test rejected by the
Supreme Court in ASARCO in order to find that the sale of the Pepsi
Subs stock was business income. The stock was not held as a
passive investment, nor as one stock in a portfolio of stocks
unrelated to Borden's unitary business. The Pepsi Subs were in the
same general line of business as Borden, were part of Borden's
unitary business, and their ultimate disposition was directly
related to Borden's restructuring, a program that would take
several years to complete. Based upon the foregoing, the
Department's decision to categorize the capital gains as business
income is not arbitrary or unreasonable and is supported by
sufficient evidence. Obasi, 266 Ill. App. 3d at 699.
Accordingly, the decision of the circuit court is affirmed in
its entirety.
Affirmed.
[fn1]The Pepsi Subs include the Pepsi-Cola Bottling Company,
Inc. of Indianapolis, Indiana; the Pepsi-Cola Bottling Company,
Inc. of Jonesboro, Arkansas; and the Pepsi-Cola Bottling Company of
Little Rock, Arkansas.