Case Title: Emerson Elec. Co. v. Tracy

Citation: 2000-Ohio-174

Docket Number: 19991879

State: ohio

Court: Ohio Supreme Court

Date: 2000-10-04T00:00:00Z

Document:
[Cite as Emerson Elec. Co. v. Tracy, 90 Ohio St.3d 157, .2000-Ohio-174.] 
 
 
 
 
 
EMERSON ELECTRIC COMPANY AND SUBSIDIARIES, APPELLANT, V. TRACY, TAX 
COMMR., APPELLEE. 
[Cite as Emerson Elec. Co. v. Tracy (2000), 90 Ohio St.3d 157.] 
Taxation — Franchise tax — R.C. 5733.04(I)(2)(c) violates the Foreign 
Commerce Clause of the United States Constitution. 
R.C. 5733.04(I)(2)(c)’s deduction limitation for foreign source dividends 
unconstitutionally discriminates against foreign commerce in violation of the 
United States Constitution’s Foreign Commerce Clause. 
(No. 99-1879 — Submitted June 7, 2000 — Decided October 4, 2000.) 
APPEAL from the Board of Tax Appeals, No. 97-S-1288. 
 
Appellant, Emerson Electric Company, is a diversified multinational 
corporation that owns several domestic and foreign subsidiaries.  During the 1992 
and 1993 tax years, appellant received both foreign and domestic dividends from 
these subsidiaries.  In preparing its Ohio franchise tax reports for these years, 
appellant deducted from its franchise tax income base one hundred percent of the 
dividends derived from its domestic subsidiaries.  However, pursuant to R.C. 
5733.04(I)(2)(c), which requires that taxpayers reduce deductions for foreign 
source dividends by fifteen percent, appellant deducted only eighty-five percent of 
its foreign dividends. 
 
Appellant later filed amended tax returns for 1992 and 1993, claiming that it 
was entitled to deduct one hundred percent of its foreign source dividends.  
Appellant contended that R.C. 5733.04(I)(2)(c)’s requirement that deductions for 
foreign source dividends be reduced by fifteen percent violates the Foreign 
Commerce Clause.  Accordingly, in its amended returns, appellant deducted one 
hundred percent of the amount of dividends received from its foreign subsidiaries 
 
 
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and sought refund of the tax paid on the fifteen percent disallowed under the 
Revised Code. 
 
Appellee, the Tax Commissioner of Ohio, denied appellant’s refund request.  
The commissioner concluded that the case law relied upon by appellant was not 
controlling and that, in any event, the commissioner is without jurisdiction to 
decide constitutional questions.  Appellant appealed the commissioner’s decision 
to the Board of Tax Appeals (“BTA”).  The BTA upheld the commissioner’s 
decision, concluding that neither the BTA nor the commissioner is empowered to 
decide constitutional questions. 
 
The matter is now before us upon an appeal as of right. 
__________________ 
 
Squire, Sanders & Dempsey, L.L.P., Bebe A. Fairchild, Terrence G. Perris, 
Abby R. Levine and David J. Young, for appellant. 
 
Betty D. Montgomery, Attorney General, and Richard C. Farrin, Assistant 
Attorney General, for appellee.  
__________________ 
 
FRANCIS E. SWEENEY, SR., J.  The issue in this case is whether R.C. 
5733.04(I)(2)(c) violates the Foreign Commerce Clause.  We answer this question 
in the affirmative, finding that R.C. 5733.04(I)(2)(c), which treats dividends from 
foreign subsidiaries less favorably than those from domestic subsidiaries, 
unconstitutionally discriminates against foreign commerce.  Accordingly, we 
reverse the decision of the BTA. 
 
Ohio levies corporate franchise taxes on a net income basis.  R.C. 5733.051.  
“Net income” is defined as “the taxpayer’s taxable income before operating loss 
deduction and special deductions.”  R.C. 5733.04(I).  Ohio adjusts net income by 
allowing taxpayers to deduct net dividends received from domestic and foreign 
subsidiaries.  R.C. 5733.04(I)(2) and (4).  The Revised Code further provides: 
 
 
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“For purposes of determining net foreign source income deductible under 
division (I)(2) * * *, the amount of gross income from all such sources * * * shall 
be reduced by: 
 
“ * * * 
 
“Fifteen per cent of the amount of dividends.”  R.C. 5733.04(I)(2)(c). 
 
In contrast, dividends derived from domestic subsidiaries can be deducted in 
their entirety.  R.C. 5733.04(I)(4), incorporating Section 243, Title 26, U.S.Code.  
Appellant contends that this disparate treatment of domestic and foreign dividends 
is unconstitutional under the Foreign Commerce Clause. 
 
The United States Constitution’s Foreign Commerce Clause provides that 
“Congress shall have Power * * * to regulate Commerce with foreign Nations.”  
Clause 3, Section 8, Article I, United States Constitution.  The term “commerce” 
includes the flow of dividends from a foreign subsidiary to its parent company.  
Kraft Gen. Foods, Inc. v. Iowa Dept. of Revenue & Finance (1992), 505 U.S. 71, 
76, 112 S.Ct. 2365, 2369, 120 L.Ed.2d 59, 66. 
 
The Foreign Commerce Clause not only grants Congress the authority to 
regulate commerce between the United States and foreign nations, it also directly 
limits the power of the states to discriminate against foreign commerce.  Wardair 
Canada, Inc. v. Florida Dept. of Revenue (1986), 477 U.S. 1, 7-8, 106 S.Ct. 2369, 
2372-2373, 91 L.Ed.2d 1, 9.  This is commonly referred to as the “dormant” or 
“negative” aspect of the Foreign Commerce Clause.  The dormant aspect of the 
Foreign Commerce Clause serves two related purposes.  First, it prevents states 
from promulgating protectionist policies.  Second, it restrains the states from 
excessive interference in foreign affairs, which are the domain of the federal 
government.  Japan Line, Ltd. v. Los Angeles Cty. (1979), 441 U.S. 434, 448-451, 
99 S.Ct. 1813, 1821-1823, 60 L.Ed.2d 336, 347-348; Natl. Foreign Trade Council 
v. Natsios (C.A.1, 1999), 181 F.3d 38, 66.  Because matters of concern to the entire 
 
 
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nation are implicated, “the constitutional prohibition against state taxation of 
foreign commerce is broader than the protection afforded to interstate commerce.”  
Kraft, 505 U.S. at 79, 112 S.Ct. at 2370, 120 L.Ed.2d at 67-68.  Where, as here, a 
statute facially discriminates against foreign commerce, it is virtually per se 
invalid.  Oregon Waste Sys., Inc. v. Oregon Dept. of Environmental Quality 
(1994), 511 U.S. 93, 99, 114 S.Ct. 1345, 1350, 128 L.Ed.2d 13, 21. 
 
The United States Supreme Court applied these principles in Kraft, supra, a 
case with facts closely paralleling those presented in the case at bar.  Kraft 
involved a challenge to an Iowa statute that allowed corporate taxpayers to deduct 
dividends received from domestic subsidiaries but did not permit a deduction for 
dividends received from foreign subsidiaries.  The court nullified the statute, 
holding that Iowa’s disparate treatment of foreign and domestic subsidiaries 
constituted facial discrimination against foreign commerce in violation of the 
Foreign Commerce Clause. 
 
In comparing R.C. 5733.04 with the statute at issue in Kraft, we find that the 
two statutes do not, in any relevant way, differ in their discriminatory effect.  Both 
laws demonstrate a preference for domestic commerce over foreign commerce, 
albeit to varying degrees.  While R.C. 5733.04 does not, as the Iowa statute did, 
entirely prohibit the deduction of dividends derived from foreign subsidiaries, this 
difference in the degree of discrimination has no constitutional significance.  When 
a tax, on its face, has discriminatory economic effects, it is not necessary to 
consider the extent of the discrimination before finding it unconstitutional under 
the Commerce Clause.  Fulton Corp. v. Faulkner (1996), 516 U.S. 325, 333, 116 
S.Ct. 848, 855, 133 L.Ed.2d 796, 806, fn. 3; Associated Industries of Missouri v. 
Lohman (1994), 511 U.S. 641, 649-650, 114 S.Ct. 1815, 1822, 128 L.Ed.2d 639, 
648; Maryland v. Louisiana (1981), 451 U.S. 725, 760, 101 S.Ct. 2114, 2136, 68 
L.Ed.2d 576, 604. 
 
 
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The commissioner attempts to distinguish Kraft on the ground that Ohio, 
unlike Iowa, permits combined-income reporting.  See R.C. 5733.052(B); Kraft, 
505 U.S. at 74, 112 S.Ct. at 2368, 120 L.Ed.2d at 64, fn. 9.  There are two basic 
systems for reporting income—single entity reporting and combined-income 
reporting.  Under the single-entity reporting system, each subsidiary corporation 
reports separately.  E.I. Du Pont de Nemours & Co. v. State Tax Assessor 
(Me.1996), 675 A.2d 82, 87, fn. 9.  In contrast, “[u]nder combined reporting, the 
income of the members of a unitary business is combined and then apportioned to 
a particular taxing jurisdiction.”  Caterpillar, Inc. v. Commr. of Revenue 
(Minn.1997), 568 N.W.2d 695, 696.  Typically, a corporation and its subsidiaries 
are deemed to comprise a “unitary business.”  “ ‘A multi-state business is a unitary 
business for income tax purposes when * * * its various parts are interdependent 
and of mutual benefit so as to form one integral business.’ ”  In re Appeal of 
Morton Thiokol, Inc. (1993), 254 Kan. 23, 24, 864 P.2d 1175, 1178.  Thus, when a 
corporation files a combined report, the corporation’s income is netted with the 
apportioned income of its subsidiaries.  There are variations of the combination 
method that differ according to whether foreign members of the unitary business 
are included in the combined reports.  The “domestic combination” method 
includes only domestic subsidiaries, while the “worldwide combination” method 
includes foreign subsidiaries.  Id., 254 Kan. at 25, 864 P.2d at 1178. 
 
A number of courts have concluded that the single-entity reporting system 
involved in Kraft raises constitutional concerns that are not present under the 
domestic-combination system.  See, e.g., id., 254 Kan. at 38, 864 P.2d at 1186; 
Caterpillar, 568 N.W.2d at 700-701; E.I. Du Pont de Nemours, 675 A.2d at 87; 
Caterpillar Fin. Serv. Corp. v. Whitley (1997), 288 Ill.App.3d 389, 399, 223 
Ill.Dec. 879, 680 N.E.2d 1082, 1088.  Accordingly, these courts have held that 
Kraft does not apply to the taxation of foreign dividends by domestic combination 
 
 
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states.  These courts reason that in domestic-combination states, the disparate 
treatment of foreign and domestic dividends is necessary to produce a kind of 
“taxing symmetry” that is not present under the single-entity method.  See, e.g., 
E.I. Du Pont de Nemours, 675 A.2d at 88; In re Appeal of Morton Thiokol, 254 
Kan. at 38, 864 P.2d at 1186.  In a domestic-combination state, the apportioned 
earnings of the domestic subsidiaries are taxed as income of the unitary business.  
Because the state has taxed the earnings out of which dividends are paid, the 
dividends themselves are not subject to taxation.  This prevents dividends from 
domestic subsidiaries from being taxed twice—once as earnings of the domestic 
subsidiary and once as separate income to the unitary business.  At the same time, 
the income of foreign subsidiaries is not taxed in a domestic-combination state.  
Thus, no discrimination results from taxing, in whole or in part, dividends derived 
from foreign subsidiaries. 
 
Relying upon this reasoning, the commissioner argues that R.C. 
5733.04(I)(2)(c) does not discriminate against foreign commerce because Ohio 
permits combined-income reporting.  According to the commissioner, the taxation 
of domestic subsidiaries under Ohio’s combination method more than offsets the 
fifteen-percent reduction in foreign source dividends.  We disagree. 
 
R.C. 5733.052(B) does permit certain corporate taxpayers to combine their 
net incomes and report as a single, unitary business.1  However, Ohio’s system of 
combined reporting differs fundamentally from that of other states.  In Ohio, the 
only entities that are permitted to combine net incomes are those having income 
“from sources within Ohio.”  As a result, a corporation can file a combined return 
only for those of its subsidiaries that earn income in Ohio.  Subsidiaries that do not 
earn income in Ohio must file separate returns.  With respect to these subsidiaries, 
Ohio’s tax system does not differ from the single-entity reporting method involved 
in Kraft. 
 
 
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Clearly, Ohio’s system of combined reporting does not produce the “tax 
symmetry” that combined reporting produces in other states.  Because domestic 
subsidiaries that do not earn income from sources within Ohio do not have their 
income combined with that of the parent company, dividends from these 
subsidiaries are not at risk of being taxed twice.  Under Ohio’s tax scheme, the 
parent company is still permitted to deduct these dividends in full.  Yet, at the same 
time, only eighty-five percent of foreign dividends may be deducted.  Such a 
preference for domestic commerce over foreign commerce cannot withstand 
constitutional scrutiny. 
 
For the foregoing reasons, we hold that R.C. 5733.04(I)(2)(c)’s deduction 
limitation for foreign source dividends unconstitutionally discriminates against 
foreign commerce in violation of the United States Constitution’s Foreign 
Commerce Clause. We therefore reverse the decision of the BTA. 
Decision reversed. 
 
MOYER, C.J., PFEIFER and LUNDBERG STRATTON, JJ., concur. 
 
DOUGLAS and RESNICK, JJ., dissent. 
 
COOK, J., dissents. 
FOOTNOTE: 
 
1. 
R.C. 5733.052(B) provides that “[a] combination of net income may * 
* * be made at the election of any two or more taxpayers each having income, 
other than dividend or distribution income, from sources within Ohio.” 
__________________ 
 
COOK, J., dissenting.  I dissented from this court’s recent decision that 
Ohio’s “bad time” law is unconstitutional, noting that the majority in that case 
failed to acknowledge the axiomatic precepts of judicial restraint applicable to 
facial challenges.  See State ex rel. Bray v. Russell (2000), 89 Ohio St.3d 132, 136-
 
 
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137, 729 N.E.2d 359, 362-363 (Cook, J., dissenting).  I respectfully dissent from 
today’s decision for similar reasons. 
 
As I noted in Bray, statutes are presumed to be constitutional.  Id. at 136, 
729 N.E.2d at 362.  In order for this court to declare otherwise, it must appear 
beyond a reasonable doubt that the statute is incompatible with particular 
constitutional provisions.  Id. at 136-137, 729 N.E.2d at 362-363, citing State v. 
Cook (1998), 83 Ohio St.3d 404, 409, 700 N.E.2d 570, 576.  We have previously 
recognized that, because of our “judicial obligation * * * to support the enactment 
of a lawmaking body if this can be done,” we will not declare a statute facially 
unconstitutional unless no set of circumstances exists under which the statute 
would be valid.  State v. Beckley (1983), 5 Ohio St.3d 4, 7, 5 OBR 66, 69, 448 
N.E.2d 1147, 1149; see, also, United States v. Salerno (1987), 481 U.S. 739, 745, 
107 S.Ct. 2095, 2100, 95 L.Ed.2d 697, 707. 
 
Without mentioning these precepts, the majority concludes that the United 
States Supreme Court’s decision in Kraft compels today’s result.  Kraft Gen. 
Foods, Inc. v. Iowa Dept. of Revenue & Finance (1992), 505 U.S. 71, 112 S.Ct. 
2365, 120 L.Ed.2d 59.  But as Chief Justice Rehnquist noted in his dissent in that 
case, the Kraft majority—like the majority here—also failed to acknowledge the 
petitioner’s burden “to demonstrate that there are no circumstances in which 
Iowa’s statute could be constitutionally applied.”  (Emphasis added.)  Id. at 84-85, 
112 S.Ct. at 2373, 120 L.Ed.2d at 71 (Rehnquist, C.J., dissenting). 
 
Even assuming, arguendo, that Kraft met its burden in that case, I cannot say 
that Emerson Electric Company has done so here.  The majority accepts Emerson’s 
contention that because domestic dividends may be deducted in full, “[y]et * * * 
only eighty-five percent of foreign dividends may be deducted,” R.C. 
5733.04(I)(2)(c) unconstitutionally discriminates against foreign commerce.  But 
the majority’s analysis bypasses the portion of the statute that expressly permits the 
 
 
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taxpayer to establish that this “deemed” amount of deductible foreign dividends is 
actually larger.  See R.C. 5733.04(I)(2)(c).  Theoretically, the application of the 
statute could result in no limit to the foreign source dividend deduction, and hence 
no discrimination.  It would seem that “the existence of such a possibility should 
be fatal to [Emerson’s] chances of success” in a facial challenge.  Kraft, supra, 505 
U.S. at 85, 112 S.Ct. at 2373, 120 L.Ed.2d at 71 (Rehnquist, C.J., dissenting).