Title: Lehman Brothers Bank v. State Bank Commissioner

State: delaware

Issuer: Delaware Supreme Court

Document:

IN THE SUPREME COURT OF THE STATE OF DELAWARE 
 
 
LEHMAN BROTHERS BANK, FSB, 
 
§ 
 
 
 
 
 
 
 
§ 
No. 656, 2006 
 
 
Appellant Below,  
§ 
 
 
 
Appellant,  
 
§ 
Court Below: Superior Court of 
 
 
 
 
 
 
 
§ 
the State of Delaware in and for 
 
v. 
 
 
 
 
§ 
New Castle County 
 
 
 
 
 
 
 
§ 
STATE BANK COMMISSIONER, 
 
§ 
 
 
 
§ 
C.A. No. 05A-06-004 
 
 
 
Appellee Below,  
§ 
 
 
Appellee. 
 
 
§ 
 
Submitted: May 23, 2007 
 
 
 
 
     Decided:    November 7, 2007 
 
 
 
 
     Modified:  November 9, 2007 
 
Before HOLLAND, JACOBS and RIDGELY, Justices. 
 
Upon Appeal from the Superior Court.  AFFIRMED IN PART, REVERSED IN 
PART and REMANDED. 
 
 
Stanford L. Stevenson, III and Anne Shea Gaza, Esquires, of Richards, 
Layton & Finger, Wilmington, Delaware;  Of Counsel:  Paul H. Frankel (argued) 
and Irwin M. Slomka, Esquires, of Morrison & Foerster, LLP, New York, New 
York; for Appellant. 
 
Thomas P. McGonigle, Esquire, of Wolf, Block, Schorr and Solis-Cohen, 
LLP, Wilmington, Delaware;  Of Counsel:  Joseph C. Bright (argued) and Cheryl 
A. Upham, Esquires, of Wolf, Block, Schorr and Solis-Cohen, LLP, Philadelphia, 
Pennsylvania; for Appellee. 
 
 
 
 
 
JACOBS, Justice: 
Appellant Lehman Brothers Bank, FSB appeals from a Superior Court 
Order1 
affirming 
a 
decision 
by 
the 
State 
Bank 
Commissioner 
(the 
“Commissioner”)2 assessing additional franchise tax and penalties against the Bank 
for the tax years 2000, 2001, 2002 and 2003.  We affirm that portion of the Order 
upholding the imposition of additional franchise tax, reverse that portion upholding 
the assessment of penalties, and remand the case for further proceedings. 
FACTS AND PROCEDURAL BACKGROUND 
 
The material facts are undisputed.  Since the 1980s, Lehman Brothers 
Holdings, Inc. (“LBH”) has operated a mortgage business whose activities consist 
of acquiring, and earning interest on, mortgages issued by independent mortgage 
lenders and brokers or by LBH’s subsidiary mortgage company, Aurora Loan 
Services, Inc. (“Aurora”).  Before 1999, LBH’s mortgage business was funded by 
unsecured bank loans, commercial paper, or short and long-term repurchase 
agreements.  Because this type of funding was unstable, LBH actively sought to 
acquire a federal savings bank, specifically to gain access to Federal Home Loan 
Bank (“FHLB”) funding, which was a more stable and efficient funding source. 
                                                 
1 Lehman Bros. Bank, FSB v. State Bank Commissioner, 2006 WL 3457649 (Del. Super.) (cited 
herein as “Super. Ct. Op.”). 
 
2 Decision of the Delaware State Bank Commissioner, dated May 20, 2005 (cited herein as 
“Comm. Dec.”).  Any references in this Opinion to the Commissioner are to the office of the 
Commissioner, not to the particular occupant of that office. 
 
 
2
In 1999, LBH acquired Delaware Savings Bank, FSB, a federal savings bank 
organized under the Federal Home Owner’s Loan Act, and subject to regulation 
and supervision by the United States Office of Thrift Supervision, and changed its 
name to Lehman Brothers Bank, FSB (the “Bank”).  The Bank’s federal stock 
charter, which became effective on June 30, 1999, designated Wilmington, 
Delaware as the Bank’s “home office.”  That designation enabled the Bank to 
access FHLB funds from the Pittsburgh FHLB. 
The Bank maintained a retail banking office—located in Wilmington, 
Delaware—for personal banking services.  That retail operation was not profitable.  
The Bank’s profitable operation was its mortgage banking business.3  In that latter 
business, the Bank had two primary sources of funds for acquiring mortgages:  (i) 
funds derived from sales of certificates of deposit (representing 25-30% of the total 
funds) and (ii) funds derived from FHLB loans (representing 50-60% of the total).  
Using those funds, the Bank acquired mortgages in one of three ways:  outright 
purchase,4 direct origination,5 and origination through a correspondent lender.6  
                                                 
3 In addition to its retail and mortgage banking activities, the Bank conducted a trust services 
operation, beginning in 2002. 
 
4 The Bank bought residential mortgage pools that were already issued and funded. 
 
5 A borrower who wanted a mortgage would apply to Aurora, which would approve the 
borrower’s credit and the mortgage under the Bank’s guidelines.  Aurora’s services were usually 
performed in Colorado. 
 
6 Another lender would underwrite and fund the loan and would then sell the mortgage to the 
Bank, through Aurora. 
 
3
The Bank customarily held the mortgages for 45-60 days—a practice generating 
interest income that represented about 97% of the Bank’s total income.  After 45-
60 days, the Bank then “sold” the mortgages to its parent company, LBH, making 
no profit on the transfer.  
Most of the Bank’s senior management was based in New York, and the 
Bank’s board of directors met approximately eight times a year in New York.  For 
the tax years in question, about 12 persons were employed at the Delaware home 
office.  Half of the Delaware employees engaged in retail banking activities, and 
half performed accounting and other support services for the Bank as a whole.  To 
conduct its mortgage banking business, the Bank employed 20-25 full-time direct 
employees in New York (all on the Bank’s payroll), 66 “dual employees” in New 
York (persons on LBH’s payroll, for whose services the Bank reimbursed LBH), 
and 24 “dual employees” in Colorado (persons on Aurora’s payroll, but for whose 
services the Bank reimbursed Aurora).  
For each of the years at issue (2000-2003) the Bank filed a Delaware 
Franchise Tax Report.  Delaware imposes a bank franchise tax on the taxable 
income of banking organizations for the privilege of doing business in this State.7  
The measure of the franchise tax depends importantly on whether the banking 
                                                 
7 See Super. Ct. Op. at *4. 
 
 
4
organization (here, a federal savings bank) is domiciled in Delaware.8  Under 5 
Del. C. § 1101(a) (“subsection (a)”), a federal savings bank with its “principal 
office” in Delaware is taxed on all its taxable income.9  But, under line 4(b) of its 
Return, a bank may deduct from its reported income the portion that was earned 
from activities conducted outside Delaware by branches or subsidiaries subject to 
income taxation under the laws of another state (a “line 4(b) deduction”).10  Under 
5 Del. C. § 1101(b) (“subsection (b)”), a federal savings bank not “headquartered” 
in Delaware is subject to a more limited bank franchise tax, imposed only on the 
income of the bank’s Delaware branches or subsidiaries, if any.  The Delaware 
bank franchise tax statute does not define the terms “principal office” or 
“headquartered.”  For ease of reference, we sometimes refer to either of those 
terms, or both interchangeably, as “domicile,” or “domiciled.” 
For the year 2000, the Bank filed its Franchise Tax Return under subsection 
(a), as had its predecessor (the Delaware Savings Bank), as a banking organization 
having its “principal office” in Delaware.  For that tax year, the Bank reported all 
its income, but claimed a line 4(b) deduction to reflect its income from activities 
                                                 
8 See 5 Del. C. § 1101. 
 
9 5 Del. C. § 1101(a) and 5 Del. C. § 101(4)(b). 
 
10 Under Section 1101(a)(1)(b)(2), a Delaware bank with out-of-state branches and subsidiaries 
may reduce its “taxable income” by “[t]hat portion of the net operating income before taxes, 
verifiable by documentary evidence … which is … [d]erived from business activities carried on 
outside [Delaware] and subject to income taxation under the laws of another state.” 
 
 
5
conducted outside Delaware, even though the Bank had no formally established 
out-of-state branches or subsidiaries.  The Commissioner’s office made no 
objection to the Bank’s 2000 Franchise Tax Return for nearly three years. 
The Bank used the same approach in filing its Franchise Tax Return for the 
tax year 2001.  The Bank filed its 2001 Return (in 2002) under subsection (a), as a 
banking organization having its “principal office” in Delaware, and again claimed 
a line 4(b) deduction.  Thereafter, the Commissioner contacted the Bank to discuss 
the Return.  During those discussions, the Commissioner requested, among other 
things, documentation to support the line 4(b) deduction.  The statute allowing that 
deduction authorizes the taxpayer to deduct “net operating income before taxes 
verifiable by documentary evidence from any subsidiary or … branch.”11  In 
response to that request, the Bank submitted, in March 2003, two “apportionment 
schedules,” consisting of one-page charts listing income purportedly allocated and 
reported to other states. 
In 2003, the Bank filed its 2002 Franchise Tax Return, again under 
subsection (a), and again claiming a line 4(b) deduction.  By letter dated October 6, 
2003, the Commissioner advised the Bank that its Returns for the tax years 2000-
2002 were incorrect, because (in the Commissioner’s view) the Bank had no basis 
to claim a line 4(b) deduction.  The Commissioner then recalculated the Bank’s tax 
                                                 
11 5 Del. Admin. C. § 1105, Item 4(b), based on 5 Del. C. § 1101(a)(1)(b)(2) (emphasis added). 
 
 
6
liability based on the disallowance of the line 4(b) deduction, and also assessed 
“late penalties.”  The Bank disputed both the assessment and the penalties.  That 
dispute prompted the Commissioner to issue a notice of proceedings under 29 Del. 
C. § 10122 for purposes of finally determining the Bank’s franchise tax liability for 
tax years 2000, 2001, and 2002. 
In response to the Commissioner’s disallowance of the line 4(b) deduction in 
its 2000-2002 Returns, the Bank did not claim that deduction in its 2003 Franchise 
Tax Return (filed in 2004).  The Bank filed its 2003 Return under subsection (a)—
as before—but instead of claiming a line 4(b) deduction, the Bank reported only 
that portion of its income it claimed to be attributable to Delaware.12  On August 2, 
2004, the Commissioner issued a revised notice of proceedings, this time covering 
the Bank’s franchise tax liability for all four years in question, i.e. 2000-2002 and 
2003.  An evidentiary hearing before the Commissioner was scheduled for 
September 30 and October 1, 2004.   
After it received the Commissioner’s August 2, 2004 notice, the Bank 
submitted amended Franchise Tax Returns for all four tax years.  The basis for the 
amended Returns was that, for all the years at issue, the Bank was not domiciled in 
Delaware, contrary to what the Bank had represented in its original Returns.  
Therefore, the Bank should be taxed under subsection (b), only on the income 
                                                 
12 The income reported on the 2003 Franchise Tax Return was, therefore, significantly less than 
the amounts reported on the Tax Returns filed for the previous three years. 
 
7
earned from its Delaware operations.  In submitting those amended Returns, the 
Bank reported that it used a separate accounting method, based on a study prepared 
by Ernst & Young, to segregate the income generated by the Bank’s Delaware 
retail operations from the income generated by the Bank’s “nationwide” mortgage 
and trust operations.  Based on that accounting method, the Bank claimed that it 
was entitled to tax refunds for all four years, totaling approximately $14 million. 
After the evidentiary hearing, the Commissioner determined that because the 
Bank was domiciled in Delaware, subsection (a) of Section 1101 was applicable.  
The Commissioner further decided that the Bank was not entitled to claim a line 
4(b) deduction, because it had no out-of-state “branches” or “subsidiaries.”  
Therefore, the Commissioner concluded that a franchise tax balance of $10.5 
million was due, and assessed “late penalties” for each tax year, at a daily rate of 
0.05% of the balance, to accrue at the same rate until the additional assessed tax 
was paid.13  The “late penalties” imposed from March 1, 2001 (the due date for the 
2000 tax) to May 20, 2005 (the date of the Commissioner’s decision) totaled 
approximately $4 million.14   
                                                 
13 See Comm. Dec. pp. 17-21.  The total assessment of $14,515,474 was divided as follows:  (1) 
for 2000: $3,209,996 franchise tax assessed; $854,996 balance due; $658,778 penalty; (2) for 
2001: $4,936,270 franchise tax assessed; $1,726,410 balance due; $1,015,123 penalty; (3) for 
2002: $7,715,354 franchise tax assessed; $3,144,482 balance due; $1,275,087 penalty; and (4) 
for 2003: $11,577,586 franchise tax assessed; $4,777,586 balance due; $1,063,012 penalty. 
 
14 Because the Bank has not paid the additional tax assessed, the aggregate penalties have 
increased to approximately $7.8 million as of the date of oral argument before this Court. 
 
8
The Bank appealed to the Superior Court, which upheld the Commissioner’s 
decision.  The Superior Court held that:  (i) the Bank was domiciled in Delaware 
for franchise tax purposes; (ii) all of the Bank’s interest income was earned in, and 
derived from, Delaware; (iii) the Commissioner’s method of assessing the tax did 
not violate the Commerce or the Due Process Clauses of the United States 
Constitution; and (iv) the Commissioner did not abuse its discretion by refusing to 
abate the tax assessment and the penalties. 
This appeal followed. 
THE CLAIMS OF ERROR:  AN OVERVIEW 
 
On appeal, the Bank advances several claims of error.  The Bank first claims 
that the Commissioner and the Superior Court reversibly erred by concluding that 
the Bank was domiciled in Delaware and, thus, subject to Section 1101(a).  The 
Bank takes the position that it was (and is) domiciled in New York, because most 
of the Bank’s employees, including its senior management, work in New York.  
Therefore, the Bank claims, the applicable franchise tax provision is not Section 
1101(a), but Section 1101(b), under which only the income attributable to a 
Delaware “branch” is subject to tax.   
Second, and alternatively, the Bank argues that even if Section 1101(a) is the 
applicable statute, the Commissioner and the Superior Court reversibly erred in 
holding that the Bank was subject to Delaware bank franchise tax on 100% of its 
 
9
income.  That was error, the Bank contends, because (i) the Bank did not earn all 
of its income in Delaware, and (ii) the statutorily prescribed manner of assessing 
the tax violates the Commerce and the Due Process Clauses.   
Third, the Bank claims that the Superior Court reversibly erred in finding 
that the Commissioner properly refused to abate the penalties.  Fourth, the Bank 
argues that if this Court finds that the Bank is entitled to a tax refund, the Bank is 
entitled to pre-judgment interest on that refund.  These claims generate the issues 
presented on this appeal. 
The first issue is whether the Bank is domiciled in Delaware.  If the Bank is 
not domiciled in Delaware, then Section 1101(b) applies and the Bank’s amended 
Franchise Tax Returns—filed under Section 1101(b)—were correct, thereby 
entitling the Bank to a tax refund.  If, however, the Bank is domiciled in Delaware, 
then the Bank is subject to Section 1101(a), in which case the question becomes 
whether the Bank was entitled to a line 4(b) deduction.  We conclude that the Bank 
was domiciled in Delaware, and that under the applicable statute—Section 
1101(a)—the Bank was not entitled to apportion its income by taking a line 4(b) 
deduction. 
The next set of issues involve whether the Delaware bank franchise tax 
statute violates the Commerce and/or the Due Process Clause.  We hold that the 
apportionment mechanism contained in the Delaware statute (which is not 
 
10
available to the Bank in this case) passes constitutional muster under the 
Commerce and the Due Process Clauses. 
The final issue is whether the Commissioner abused its discretion by 
refusing to abate the penalties assessed.  We conclude that in these specific 
circumstances the Commissioner abused its discretion by not abating the penalties 
and that the Superior Court erred in holding otherwise. 
STANDARD OF REVIEW AND  
ANALYSIS OF THE CLAIMS OF ERROR  
 
In reviewing an administrative agency’s decision, this Court determines 
whether the factual findings of the agency are “supported by substantial evidence 
on the record before the agency.”15  Where, as here, the agency has interpreted and 
applied statutory provisions, those determinations involve questions of law16 that 
this Court reviews de novo.17  
Section 1101(a) Is Applicable Because  
The Bank Was Domiciled in Delaware 
  
Section 1101(a) of the bank franchise tax statute applies to federal savings 
banks having their “principal office” in Delaware.  Section 1101(b) applies to 
                                                 
15 Public Water Supply Co. v. DiPasquale, 735 A.2d 378, 380-81 (Del. 1999) (citing Stoltz 
Mgmt. Co., Inc. v. Consumer Affairs Bd., 616 A.2d 1205, 1208 (Del. 1992)). 
 
16 Hubbard v. Hibbard Brown & Co., 633 A.2d 345, 349 (Del. 1993); Bd. of Educ. of Smyrna 
School Dist. v. DiNunzio, 602 A.2d 85, 92-93 (Del. 1990); Public Water, 735 A.2d at 380-81. 
 
17 Del. Bay Surgical Serv., P.C. v. Swier, 900 A.2d 646, 652 (Del. 2006) (citing Coastal Barge 
Corp. v. Coastal Zone Ind. Control Bd., 492 A.2d 1242, 1246 (Del. 1985)). 
 
 
11
federal savings banks that are not “headquartered” in Delaware.  From the structure 
of Section 1101, it is evident that the terms “principal office” and “headquarter[s]” 
are used interchangeably.18  Neither term is defined in Chapter 5 (Banking) of the 
Delaware Code, of which Section 1101 is a part.  This Court must therefore 
ascertain the meaning of those terms, which requires us to interpret the Delaware 
bank franchise tax statute, as applied to a federal savings bank. 
The Bank argues that in interpreting the statute, the terms “principal office” 
and “headquarter[s]” must be given their ordinary meaning.  According to the 
Bank, the ordinary meaning is “commercial domicile,” defined as “the place from 
which the trade or business is principally managed or directed.”19  Under that 
definition the Bank’s “commercial domicile” would be New York, because the 
Bank’s executive officers are employed in New York, its board of directors meets 
exclusively in New York, its regulatory examinations are conducted in New York, 
and most of its mortgage-related decisions are made in New York.   
                                                 
18 See Chrysler Corp. v. State, 163 A.2d 239, 241 (Del. 1960) (holding that where similar terms 
are used in different subsections of the same provision, those terms should be construed to have 
the same meaning).  The Report on “State and Local ‘Doing Business’ Taxes on Out-of-State 
Financial Depositories” of the United States Advisory Commission on Intergovernmental 
Relations, dated May 1975 (the “ACIR Report”) recognizes that the terms “domicile,” “principal 
office,” “home office,” and “headquarters” are synonymous.  See ACIR Report, p. 53. 
 
19 The “ordinary meaning” definitions suggested by the Bank are extracted either from 
dictionaries or from regulations that are not applicable in Delaware:  the Uniform Division of 
Income for Tax Purposes Act (UDITPA) and a Model Statute adopted by the Multistate Tax 
Commission  (MTC).  Delaware has not adopted the UDITPA and is not a member of the MTC. 
 
 
12
We disagree with the Bank’s interpretation.  The rule of construction which 
requires that an undefined statutory term be given its ordinary meaning does not 
apply to terms of art.  Under the general rules of statutory interpretation set forth in 
the Delaware Code, “technical words and phrases ... [must] be construed and 
understood according to [their] peculiar and appropriate meaning.”20  Here, the 
terms “principal office” and “headquarter[s]” are terms of art and, therefore, must 
be given their “peculiar and appropriate meaning.”  Because those terms are used 
in a statute imposing a tax upon “banking organizations”—entities that include 
federal savings banks—we conclude that the appropriate meaning of “principal 
office” and “headquarter[s]” is the meaning accorded those terms by the 
regulations that govern federal savings banks and their taxation. 
The Code of Federal Regulations (CFR)21 requires that all federal savings 
banks designate a “home office.”22  Under the CFR, “home office” is synonymous 
with “principal office.”  The latter term is employed in Section 1101 of the 
                                                 
20 1 Del. C. § 303.  See also Shell Petroleum, Inc. v. U.S., 182 F.3d 212, 217-18 (3rd Cir. 1999) 
(citing Corning Glass Works v. Brennan, 417 U.S. 188, 202 (1974)). 
 
21 This Court has used federal definitions when a Delaware tax statute did not clearly define a 
term.  See Director of Revenue v. CNA Holdings, Inc., 818 A.2d 953, 957-59 (Del. 2003).  
Several provisions in Chapter 30 (Taxation) of the Delaware Code actually require that certain 
statutory terms be given the same meaning as when used in federal laws.  See, e.g., 30 Del. C. § 
502(a), § 1101, § 2071.  See also Gow v. Director of Revenue, 556 A.2d 190, 193 (Del. 1989). 
 
22 See 12 C.F.R. § 545.91(a) which provides that “[a]ll operations of a Federal savings 
association are subject to direction from the home office.” 
 
 
13
Delaware statute.23  Here, the Bank’s federal stock charter explicitly designates 
Wilmington, Delaware as the “home office.”  The CFR further mandates that if a 
federal bank wishes to change its home office address, it must apply to the United 
States Office of Thrift Supervision (“OTS”).24  The Bank has never applied to the 
OTS to change the location of its Wilmington, Delaware home office.  Therefore, 
under the CFR, the Bank is domiciled in Delaware. 
Other applicable regulations lead to the same conclusion.  12 U.S.C. § 
1424(b) prescribes that a federal savings bank “may become a member only of, or 
secure advances from, the Federal Home Loan Bank of the district in which is 
located the institution’s principal place of business.”25  Here, the Bank borrowed 
exclusively from the FHLB in Pittsburgh, which serves Delaware—but not New 
York—federal savings banks.  We regard this course of conduct as evidence that 
the Bank considered its “principal place of business” to be Delaware, not New 
York.   
The Delaware bank franchise tax statute also points to the conclusion that 
the Bank is domiciled in Delaware.  Although that statute does not define 
                                                 
23 See 12 C.F.R. § 561.39 (“The term principal office means the home office of a savings 
association established as such in conformity with the laws under which the savings association 
is organized.”)  See also 12 C.F.R. § 925.18(b) (“the principal place of business … is the state in 
which the institution maintains its home office.”) 
 
24 See 12 C.F.R. § 545.91(b). 
 
25 12 U.S.C. § 1424(b) (emphasis added). 
 
 
14
“principal office” and “headquarter[s],” it does define a similar term—“located”—
that appears in both subsections of Section 1101.26  Under 5 Del. C. § 831(8), a 
savings institution is “located” in “the state in which the amount of aggregate 
deposits of all its offices in that state is greatest.”27  The Bank had only one office 
where its deposit operations were conducted.  That office was located in Delaware.   
Finally, we note a recent amendment to the Delaware bank franchise law 
that defines, for the first time, the term “headquarters.”  Under the new provision, 
the “headquarters” of a national banking association are located “in the state of the 
bank’s home office as designated in its charter.”28  Although that amendment is 
effective for tax years post-2006 (and, thus, not applicable here), the definition it 
adopts is instructive and fully supports the interpretation reached here.29 
For these reasons, we conclude that both the Commissioner and the Superior 
Court correctly held that the Bank was domiciled in Delaware for franchise tax 
                                                 
26 Section 1101 cross-references Section 801(5) for the definition of the word “located.”  Section 
801(5) provides that a bank is “located” in Delaware if the “organization certificate identifies an 
address in [Delaware] as the place at which its discount and deposit operations are to be carried 
out.”  That definition is applicable to state-chartered banks and national banks.  However, a 
similar definition, specifically applicable to savings institutions, is contained in Section 831(8). 
 
27 5 Del. C. § 831(8). 
 
28 See 5 Del. C. § 1101A(c)(9) (emphasis added).  National banks are subject to regulations 
which are very similar to those governing federal savings banks. 
 
29 See Chrysler Corp. v. State, 163 A.2d 239, 241 (Del. 1960) (“A change in the phraseology of 
the amendment creates a presumption that the Legislature intended a change of meaning.”) 
 
 
15
purposes.  As a consequence, Section 1101(a) was the applicable provision for 
computing the Delaware bank franchise tax. 
The Bank Is Not Entitled To A Line 4(b)  
Deduction Under Section 1101(a) 
 
Under Section 1101(a), the entire net income of federal savings bank 
domiciled in Delaware is taxed by Delaware, unless that entity has an out-of-state 
“branch” or “subsidiary.”  In that case, the income attributable to the branch or 
subsidiary may be deducted from the total reported income, subject to certain 
limitations.  For a line 4(b) deduction to be available, however, the income sought 
to be excluded must be:  (a) derived from business activities carried in other states 
through “branches” or “subsidiaries,” (b) “verifiable by documentary evidence,” 
and (c) subject to income taxation under the laws of another state.30  The Superior 
Court and the Commissioner held that the Bank did not satisfy these conditions.  
We uphold their determination. 
Regarding the first condition, it is undisputed that the OTS must approve the 
establishment of “branches” and “subsidiaries,”31 and that during the years in 
question the Bank had no OTS-approved branches or subsidiaries.32  The Bank 
                                                 
30 See 5 Del. C. § 1101(a); 5 Del. Admin. C. § 1105, Item 4(b). 
 
31 See 12 C.F.R. §§ 545.93(a), 559.3 and 559.11. 
 
32 Until January 2004, the Bank had no out-of-state branches, and its only Delaware branch 
closed in December 2000.  On August 6, 2003, the Bank applied to the OTS for approval to open 
a branch in New Jersey, which was granted, effective January 26, 2004.  See Comm. Dec., p. 6. 
 
16
requested OTS’ approval to open a branch in New Jersey (to be effective January 
2004), but it never sought OTS’ approval to establish a New York branch.  Rather, 
the Bank applied only for approval of an “agency office” in New York, “solely to 
conduct trust activities.”  The distinction is significant, because “agency offices” 
are expressly excluded from the CFR definition of “branch.”33 
The Bank asserts, nonetheless, that for franchise tax purposes it had de facto 
branches in the other states to which it “paid more than $106 million in state and 
local income taxes.”34  This argument has no legal force.  Congress has decreed  
that any “branches” must be approved by the OTS.  That requirement reflects a 
policy judgment that a branch is more than a verbal label—it is a geographical 
location where a monopoly activity may be lawfully conducted.35  Because 
approval of a branch authorizes the taking of deposits and the making of loans by 
the branch exclusively at that particular location, there is no such thing as a de 
facto branch in the federally regulated banking industry. 
                                                 
33 “Any office other than [the] home office, agency office, administrative office, data processing 
office, or an electronic means or facility.”  See 12 C.F.R. § 545.92(a) (emphasis added). 
 
34 This assertion is based on a report prepared by PricewaterhouseCoopers, which contains a one-
page chart listing other states where the Bank paid taxes during the years at issue (e.g. New 
York, California and Colorado) and the amounts paid in each state. 
 
35 Delaware regulations similarly make the opening of a branch by a state bank subject to the 
State Bank Commissioner’s approval.  A branch is defined as “any location ... at which deposits 
are received or checks paid or money lent.”  See 5 Del. C. § 770(a)(1). 
 
 
17
Faced with this insurmountable legal obstacle, the Bank attempts to 
circumvent it by arguing that requiring a taxpayer bank to establish a formal 
branch to avail itself of the line 4(b) deduction “does not reflect modern banking 
practices.”  Under such “modern practices,” the Bank asserts, certain mortgage 
banking related activities may be conducted without prior OTS approval, through 
an out-of-state “agency office.”  It is the case that federal savings banks are 
allowed, under federal law, to conduct limited activities through agency offices 
without OTS approval.36  Even so, this limited exception does not aid the Bank’s 
position, because the Delaware bank franchise tax statute permits a line 4(b) 
deduction only on income earned by an out-of-state “branch” or “subsidiary,” and, 
under federal law, an “agency office” is not a “branch.”  Accordingly, the 
Commissioner properly held that the absence of any OTS-approved branches or 
subsidiaries precludes the Bank from taking advantage of the line 4(b) deduction. 
Even if we accepted the Bank’s argument that an OTS-approved branch was 
not required to enable the Bank to take a line 4(b) deduction, other conditions for 
utilizing that deduction remain unsatisfied.  First, the Bank failed to provide (either 
at the time of filing or after) “documentary evidence” verifying that the portion of 
the income it sought to exclude from the taxable income reported in Delaware was 
                                                 
36 See 12 C.F.R. § 545.96.  Those activities are limited to “[s]ervicing, originating, or approving 
loans and contracts” and “managing or selling real estate.”  
 
 
18
“derived from business activities carried in other States.”37  The only documents 
furnished by the Bank were “apportionment schedules” that listed the percentages 
of the Bank’s total income that were “allocated” to other states.  Those schedules 
did not explain how those percentages were calculated, and, moreover, covered 
only tax years 2000 and 2002, even though the Bank also claimed the line 4(b) 
deduction for tax year 2001.  As the Superior Court noted, the Bank should have 
prepared “a separate Delaware balance sheet accounting for the money earned in 
Delaware.”38  Second, the Bank failed to prove that other states were taxing the 
line 4(b) deducted income.  As the Superior Court found, the Bank did not 
establish whether the other states “taxed the same mortgage interest income, or if 
they taxed other transactions, such as an origination fee or transfer fee.”39 
The Bank Is Not Entitled To  
Any Other Apportionment 
 
Having determined that the Bank was not entitled “to account for its out-of-
state operations” by taking a line 4(b) deduction, we must decide whether the Bank 
was allowed to apportion its income in some different manner.  The Bank claims 
that, to the extent the Delaware statute does not allow apportionment, the United 
                                                 
37 5 Del. C. § 1101(a)(1)(b)(2); 5 Del. Admin. C. § 1105, Item 4(b). 
 
38 Super. Ct. Op., at *7. 
 
39 Super. Ct. Op., at *7.  The only evidence produced by the Bank is the one-page chart included 
in the PricewaterhouseCoopers report confirming the accuracy of Ernst & Young’s analysis 
regarding the separate accounting method used in the amended Franchise Tax Returns. 
 
19
States Constitution requires that result.  Specifically, the Bank argues that the 
Commissioner and the Superior Court reversibly erred in holding that Delaware 
could tax 100% of the Bank’s income because (i) in fact, the Bank did not earn all 
of its income in Delaware, and (ii) the tax assessed on that counterfactual basis 
violates the Commerce and the Due Process Clauses. 
We initially dispose of the Bank’s first argument.  The Bank goes to great 
pains to argue that the activities which generated its mortgage-related funding and 
income “all took place outside Delaware, principally in New York.”  Both the 
Superior Court and the Commissioner determined, however, that “all [the Bank’s] 
income was actually earned in and derived from sources in Delaware.”40  Under 
Delaware’s taxation scheme, the entire net income of a federal savings bank 
having its home office in Delaware is taxed by Delaware, except for income 
attributable to out-of-state branches or subsidiaries.  Under that scheme, where the 
Bank’s income was in fact earned is not a relevant inquiry, because the statute 
authorizes Delaware to tax the Bank’s entire income.41  To say it differently, to 
resolve the constitutional issues we need not determine what portion of the income 
                                                 
40 Super. Ct. Op., at *6. 
 
41 See 5 Del. C. § 1101(a).  Delaware’s statutory scheme is in line with the recommendations of 
the ACIR Report on “State and Local ‘Doing Business’ Taxes on Out-of-State Financial 
Depositories” that where a financial depository is subject to franchise tax in more than one state, 
“the domiciliary State (ordinarily the State of the principal, headquarters, or home office) may 
apply its tax on the entire income ..., but shall allow ... a credit against such tax liability for 
similar taxes paid to other States.”  See ACIR Report, p. 53 (emphasis added). 
 
 
20
was in fact earned in Delaware and what portion, if any, was in fact earned 
elsewhere.42  Rather, the inquiry is whether Delaware’s taxation scheme 
“reasonably” reflects the in-state component of the activity being taxed43 (under 
the Commerce Clause) and whether there is a “rational” relationship between the 
taxed income and the values connected with the taxing state44 (under the Due 
Process Clause).  For the reasons next discussed, we conclude that Delaware’s 
bank franchise tax statute passes muster under both constitutional provisions. 
A.  Commerce Clause Analysis 
 
The Commerce Clause authorizes Congress to “regulate Commerce ... 
among the several States.”45  Although the Commerce Clause is expressed as an 
“affirmative grant of power,” the United States Supreme Court has consistently 
held that the Commerce Clause also contains a negative implication, known as the 
                                                 
42 In Moorman Mfg. Co. v. Bair, 437 U.S. 267, 273 (1978), the United States Supreme Court 
noted that most apportionment formulas are imprecise and “will occasionally over-reflect or 
under-reflect income attributable to the taxing State.” 
 
43 Goldberg v. Sweet, 488 U.S. 252, 262 (1989).  See also Container Corp. of Am. v. Franchise 
Tax Bd., 463 U.S. 159, 169 (1983) (holding that “the factor or factors used in the apportionment 
formula must actually reflect a reasonable sense of how income is generated”). 
  
44 Moorman, 437 U.S. at 273 (1978) (citing Norfolk & Western R. Co. v. State Tax Comm’n, 390 
U.S. 317, 325 (1968)).  See also Quill Corp. v. North Dakota, 504 U.S. 298, 305-06 (1992) 
(quoting Miller Brothers Co. v. Maryland, 347 U.S. 340, 344-45, (1954)). 
 
45 U.S. Const. Art. I, § 8, cl. 3. 
 
 
21
Dormant Commerce Clause, which prohibits certain state actions that interfere 
with interstate commerce.46 
A taxpayer challenging a state taxation statute carries the burden of 
overcoming the presumption of constitutionality with clear and convincing 
evidence.47  To determine a statute’s constitutionality under the Dormant 
Commerce Clause, the United States Supreme Court has consistently applied the 
Complete Auto Transit, Inc. v. Brady48 test.  Under that test, a tax will be upheld if:  
(1) it is applied to an activity having a substantial nexus to the taxing state, (2) it is 
fairly apportioned, (3) it does not discriminate against interstate commerce, and (4) 
it is fairly related to the services provided by the taxing state.49  The Bank’s 
Commerce Clause claim is limited to the second prong of Complete Auto.50 
                                                 
46 See, e.g., Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 179-80 (1995); Quill 
Corp. v. North Dakota, 504 U.S. 298, 309 (1992); Northwestern States Portland Cement Co. v. 
Minnesota, 358 U.S. 450, 458 (1959).  
 
47 See Atlantis J Condo. Ass’n v. Bryson, 403 A.2d 711, 714 (Del. 1979); Justice v. Gatchell, 325 
A.2d 97, 102 (Del. 1974).  In particular, a strong presumption of validity exists for the state 
taxing statutes.  See Kunkel’s Estate v. U.S., 689 F.2d 408, 424 (3rd Cir. 1982).  See also Estate 
of Kunze v. C.I.R., 233 F.3d 948, 954 (7th Cir. 2000). 
 
48 430 U.S. 274 (1977). 
  
49 See Complete Auto, 430 U.S. at 279. 
 
50 The Bank does not dispute that the tax complies with Complete Auto’s other three 
requirements.  However, the Superior Court analyzed in detail all four prongs and concluded that 
each of them was satisfied.  See Super. Ct. Op., at *9-10. 
 
 
22
Specifically, the Bank argues that the Delaware bank franchise tax is not 
fairly apportioned, because the statute does not allow a federal savings bank that is 
domiciled in Delaware and has no out-of-state branches to apportion its income to 
account for income-generating operations conducted in other states.  The 
Commissioner responds that the Complete Auto test, and its fair apportionment 
requirement, are inapplicable in this case.  Therefore, we must first address a 
threshold issue:  whether Complete Auto is applicable at all.  We  conclude that it 
is.  
1) Complete Auto Is Applicable 
The Commissioner contends that the Complete Auto test established to 
implement the Dormant Commerce Clause does not apply here, for two reasons.  
First, the Commissioner argues, Congress affirmatively exercised its power to 
regulate interstate commerce in this area by enacting Section 1464(h) of the 
Federal Home Owner’s Loan Act (HOLA).  Therefore, the Commerce Clause is 
not “dormant” and may not be used as a basis to attack the constitutionality of a 
Delaware statute adopted under the authority affirmatively delegated by the 
Congress to the states in Section 1464(h) of HOLA. 
We conclude that the Dormant Commerce Clause is applicable.  Section 
1464(h) authorizes states to tax federal savings associations, but provides that such 
state taxes may not be “greater than that imposed ... on other similar local mutual 
 
23
or cooperative thrift and home financing institutions.”51  That is, Congress 
affirmatively exercised its power to regulate the interstate commerce only in a 
limited way, i.e. to prohibit discriminatory state taxation of federal savings 
associations.  Congress did not, however, affirmatively legislate to regulate any 
other aspect of state taxation of federal savings associations.  As the United States 
Supreme Court has held, “federal regulation of a field of commerce should not be 
deemed preemptive of state regulatory power in the absence of persuasive reasons 
– either that the nature of the regulated subject matter permits no other conclusion, 
or that the Congress has unmistakably so ordained.”52  Here, there is no 
“unmistakable” evidence that Congress intended affirmatively to regulate the entire 
field53 of state taxation of federal savings banks.  Therefore, Section 1646(h) of 
HOLA does not displace the Dormant Commerce Clause. 
Second and alternatively, the Commissioner argues that even if the Dormant 
Commerce Clause applies Complete Auto’s requirement of fair apportionment is 
limited to non-domiciliaries.  Therefore, Delaware domiciliaries such as the Bank 
may be taxed without any apportionment restrictions.  Stated differently, the 
                                                 
51 See 12 U.S. Code § 1464(h), enacted in 1933. 
 
52 Florida Lime & Avocado Growers, Inc. v. Paul, 373 U.S. 132, 142 (1963). 
  
53 See Southern Railway Co. v. D.L. Reid et al., 222 U.S. 424 (1912); Lemke v. Farmers’ Grain 
Co. of Embden, 42 S. Ct. 244 (1922). 
 
 
24
Commissioner urges that “a state has the constitutional power to tax all of the 
income of its residents, no matter where that income is earned.”54 
The United States Supreme Court has not yet decided whether a state may 
constitutionally tax the unapportioned net income of a domiciliary entity that 
derives income from other states in which it conducts business.  This issue was 
addressed, however, by the Supreme Court of Rhode Island in Commercial Credit 
Consumer Services, Inc. v. Norberg.55  That case (Commercial Credit) involved a 
tax similar to the one at issue here, on banking institutions organized or 
incorporated under the laws of Rhode Island (the taxing state).  The tax was  
computed on “net income” from any sources.  The Rhode Island statute allowed no 
apportionment, but permitted the domiciliary to deduct its ordinary and necessary 
expenses of doing business from “gross income.”  Those deductible expenses 
included taxes paid to other states in which the domiciliary conducted business.  
Underscoring the novelty of the issue, the Rhode Island Supreme Court held that 
“modern doctrine ... appears to permit, either under the commerce clause or the due 
                                                 
54 Comm. Dec., at p. 15, citing Oklahoma Tax Comm’n v. Chicksaw Nation, 515 U.S. 450, 462-
63 (1995); New York ex rel. Cohn v. Graves, 300 U.S. 308, 313 (1937); Lawrence v. State Tax 
Comm’n, 286 U.S. 276 (1932); Chase Manhattan Bank v. Gavin, 733 A.2d 782 (Conn. 1999).  
Those cases dealt with various taxes imposed upon pure “locals” (either resident individuals or 
domestic corporations) whereas here we must determine whether a specific tax (the bank 
franchise tax) is applicable to a specific entity (a federal savings bank with its “home office” in 
Delaware but conducting multi-state operations). 
 
55 518 A.2d 1336, 1337 (R.I. 1986). 
 
 
25
process clause, a state to tax [local] businesses engaged in interstate commerce so 
long as the tax is applied to an activity that bears a substantial nexus to the taxing 
state, is fairly apportioned, does not discriminate against interstate commerce, and 
is fairly related to the services provided by the state”, i.e. the Complete Auto 
requirements.56  After conducting a Complete Auto analysis, the Court concluded 
that the Rhode Island tax satisfied the Commerce Clause.57  The Court emphasized 
that it was a net-income tax58 (as opposed to a gross receipts tax), that the statute 
allowed for deduction of taxes paid in other states, and that the taxpayer entity had 
failed to clearly show what taxes had been levied by other states. 
Although the Commercial Credit case is not binding on us, we regard its 
conclusion—that Complete Auto is the appropriate analytical framework—as 
highly persuasive.  Here, like in Commercial Credit, the Bank, although domiciled 
in the taxing state and having no out-of-state branches or subsidiaries, was 
                                                 
56 Id. (citing Complete Auto, 430 U.S. at 279) (emphasis added). 
 
57 Contrary to what the Bank argues, it is irrelevant that Rhode Island amended its relevant 
statute in 1995 to permit banks to apportion their income.  See People v. Regelin, 443 N.W.2d 
436, 438 (C.A. Mich. 1989).  Moreover, the Commercial Credit ruling (i.e. that if the Complete 
Auto requirements are met, a State may tax the entire net income of a domestic entity which 
conducts all or some of its business out-of-state) was implicitly endorsed in District of Columbia 
v. Chase Manhattan Bank, 689 A.2d 539, 542-43 (D.C. App. 1997). 
 
58 See United States Glue Co. v. Oak Creek, 247 U.S. 321 (1918) (distinguishing between a tax 
upon gross receipts—more likely to impede or discourage the conduct of commerce—and a tax 
upon the net income, arising from whatever source, which would be constitutional if there is no 
discrimination against interstate commerce). 
 
 
26
nevertheless “engaged in interstate commerce.”59  By parity of reasoning, we 
conclude that the Complete Auto test controls the Commerce Clause analysis. 
2) Complete Auto’s Fair Apportionment  
    Requirement Is Satisfied 
 
We now reach the Bank’s claim that the second prong of Complete Auto is 
not satisfied, because under the Delaware statute the tax is not fairly apportioned.  
The applicable Delaware bank franchise tax has a two-fold “structural” 
apportionment mechanism.  First, a bank domiciled in Delaware would not be 
taxed on income attributable to (OTS-authorized) out-of-state branches or 
subsidiaries, to the extent that other states tax that portion of the income.  Second, 
a bank not domiciled in Delaware would be taxed only on the income attributable 
to a Delaware branch or subsidiary.   
The Bank first contends that, by amending the statute in 2006, the Delaware 
Legislature “recognized the constitutional infirmities of the existing regime.”  
Under the 2006 amendment, a bank may choose to be taxed under the Section 1101 
method (as occurred here) or under an alternative method established in Section 
1101(A) (which was not available to the Bank for the tax years at issue).  The 
alternative franchise tax is the sum of two components:  (1) a tax on the “entire net 
                                                 
59 The purpose of the Commerce Clause is not “to relieve those engaged in interstate commerce 
from their just share of state tax burden even though it increases the cost of doing the business.”  
See Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 182-83 (1995) (citing Western 
Live Stock v. Bureau of Revenue, 303 U.S. 250, 254 (1938)). 
 
 
27
income” that is apportioned to the state of Delaware, and (2) a location benefit tax 
“reflecting the value of utilizing Delaware’s banking laws and bank system.”  The 
three factors used for apportionment are property, payroll, and receipts.60   
We find no merit to the Bank’s contention that the 2006 amendment exposes 
the constitutional infirmity of the pre-amendment scheme.  Absent legislative 
history showing the contrary, a statutory amendment will not be regarded as 
indicative that the predecessor version was unconstitutional.61  Here, the legislative 
history indicates that the purpose of the amendment was “to promote economic 
development”62 in Delaware.  There is no evidence of any purpose to correct any 
perceived unconstitutionality of the original version. 
Under Complete Auto’s second prong, a tax is fairly apportioned if it is 
internally and externally consistent.63  Nowhere in its briefs does the Bank dispute 
that the internal consistency test is met.  The Superior Court held that the internal 
consistency test was satisfied because “[i]f every state’s franchise tax included 
                                                 
60 See 5 Del. C. § 1101(A). 
 
61 See People v. Regelin, 443 N.W.2d 436, 438 (C.A. Mich. 1989), where the court found that 
“reliance on the amendment [of a criminal statute] to support a conclusion that the Legislature 
recognized a constitutional infirmity in the existing statute” was “arguable.”  
 
62 See Synopsis of S.B. 249, 143rd Gen. Assem. (Del. 2006). 
 
63 See Container Corp. of Am. v. Franchise Tax Board, 463 U.S. 159, 169 (1983); Goldberg v. 
Sweet, 488 U.S. 252, 261 (1989). 
 
 
28
mortgage interest only when its banks held the mortgages, there would not be 
multiple taxation.”64  The Bank does not challenge this determination on appeal. 
What the Bank claims is that the tax, as imposed, was not “externally 
consistent” because it was unapportioned and resulted in multiple taxation.  The 
focus of the external consistency inquiry is upon the economic justification for the 
state’s claim upon the value taxed.65  That inquiry is whether the “factors used in 
the apportionment formula … actually reflect a reasonable sense of how income is 
generated.”66  The Bank cites no cases addressing an apportionment system that is 
similar to that employed by the Delaware statute.  The federal cases cited by the 
Bank67 merely reiterate the undisputed and well-settled proposition that external 
consistency mandates that states tax “only that portion of the revenues from the 
interstate activity which reasonably reflects the in-state component of the activity 
being taxed.”68     
                                                 
64 Super. Ct. Op., at *9. 
 
65 Oklahoma Tax Comm’n v. Jefferson Lines, Inc., 514 U.S. 175, 185 (1995). 
 
66 Container Corp., 463 U.S. at 169. 
 
67 City of Modesto v. National Med., Inc., 128 Cal. App. 4th 518 (2005); Philadelphia Eagles 
Football Club, Inc. v. City of Philadelphia, 823 A.2d 108. 134 (Pa. 2003); Southern Pacific 
Transp. Co. Inc. v. State, Dept. of Revenue, 44 P.3d 1006 (Ariz. Ct. App. 2002); City of 
Winchester v. Am. Woodmark Corp., 471 S.E.2d 495, 498 (Va. 1996).  Those cases analyze 
various (different) systems of apportionment, or lack thereof.   
 
68 Goldberg v. Sweet, 488 U.S. 252, 261 (1989). 
 
 
29
Delaware’s apportionment system is “structural.”  That is, the bank franchise 
tax statute apportions income according to the banking entity’s structure:  home 
office, branches, and subsidiaries.  Structural apportionment is peculiarly tailored 
to banks, which are heavily regulated entities.  The activities that a bank may 
conduct are restricted, the places (branches, subsidiaries, agency offices) where a 
bank may conduct those activities are specified, and both are subject to a detailed 
system of regulatory accounting and financial control.  The Bank argues that 
Delaware’s structural apportionment system is flawed because the only permissible 
apportionment factor is the source of the income (i.e., where the income was 
earned), not how the entity is structured or how the income is earned.  None of 
Bank’s cited authorities supports its proposition.69  Apart from the requirement of 
reasonableness, the United States Supreme Court has expressly declined to impose 
constitutional constraints on a state’s selection of a particular income allocation 
formula.70  As the Commissioner observed, states have “wide latitude” in devising 
                                                 
69 The typical apportionment formula used in most states combines three factors:  tangible 
property, payroll and sales.  We observe that “tangible property” is an asset, “payroll” is an 
expense, and only the “sales” factor represents income (more precisely, gross income).  If (as the 
Bank argues) only income—and its source—is an appropriate apportionment factor, then it 
seemingly follows that the apportionment formula employed by most states is unconstitutional.  
However, the United States Supreme Court has specifically approved the classical apportionment 
formula.  See Container Corp. and Barclays Bank PLC v. Franchise Tax Bd. of Cal., 512 U.S. 
298 (1994). 
 
70 Moorman Mfg. Co. v. Bair, 437 U.S. 267, 274 (1978) (upholding a single-factor formula). 
 
 
30
constitutionally sufficient methods of fairly apportioning the income.71  Delaware’s 
system need not be the only method of apportioning income, nor need it be the 
“best” method in the view of any particular taxpayer.  The Constitution does not 
require that Delaware conform to the prevailing approach adopted by other states.72  
All that is required is that the system chosen be reasonable.  In our view, that 
requirement is met here. 
Taxing the Bank’s entire net income “reasonably reflects the in-state 
component” of its activity, namely, that the funds generated by the Bank’s 
domiciliation in Delaware “fueled [LBH’s] entire mortgage banking business.”73  
To acquire mortgages, the Bank had two primary funding sources:  money 
generated by certificates of deposit sales and FHLB loans.  The Bank held the 
mortgages purchased with those funds for 45 to 60 days, and the interest 
                                                 
71 Comm. Dec., at p. 14.   
72 In Container Corp. and Barclays Bank, the United States Supreme Court analyzed California’s 
franchise tax, applied on an entity’s “worldwide combined income.”  The plaintiffs claimed that 
a “separate accounting” method of apportionment—treating each corporate entity of a multi-state 
corporation separately for the tax purposes—should be employed rather than the three-factor 
apportionment classical formula.  The Supreme Court upheld the classical formula, noting that 
California was not required no give up the allocation method chosen, where both methods 
presented “inescapable imprecision” and both “sometimes result[ed] in double taxation.” 
 
73 Super. Ct. Op., at *9.  After LBH acquired the Bank, up to 90% of the funds for LBH’s 
mortgage business came from the Bank.  See Super. Ct. Op., at *2. 
 
 
31
accumulated during that period generated almost 100% of the Bank’s income.74  
The bank franchise tax is directed to that interest income, and only to that income.  
As the Superior Court correctly observed, “Delaware did not tax any other 
transactions.  It did not tax the Bank’s activities outside Delaware, such as 
Aurora’s lending in Colorado.  Nor did [Delaware] tax the loans and the interest 
income after they were moved from Delaware to New York.”75     
With respect to the first source of funding (certificates of deposit), LBH 
would not have had access to it without the Bank.  Only a bank may accept 
deposits and issue certificates of deposit; therefore, the deposits were accepted at 
the Bank and the certificates were issued in the Bank’s name.  These operations all 
took place in Delaware.  Attributing income generated by deposits to the place 
where a bank has its franchise to operate and is the only location at which deposits 
are accepted, is reasonable.  The Bank’s home office was in Wilmington, 
Delaware.  The Bank’s sole retail banking office, where all deposits were received, 
was established and staffed in Wilmington, Delaware.  That the Bank had officers 
and employees at locations other than Wilmington does not weaken Delaware’s 
“reasonable” economic justification for imposing the tax.   
                                                 
74 As one representative of the Bank testified “[W]e sent the money to Delaware because that’s 
where ... our operating account was....  [I]t has to hit the books and records somewhere.  It can’t 
really hit your books and records in New York.  It has to hit your books and records in the bank.” 
 
75 Super. Ct. Op., at *9 (emphasis added).  
 
 
32
Regarding the second source of funding, only the Bank, not LBH, could (and 
did) receive FHLB loans.  By virtue of being a Delaware-based federal savings 
association, the Bank was able to obtain loans from the Pittsburgh FHLB.   
The Bank disputes this conclusion, arguing that LBH would have had access 
to federally insured deposits and FHLB loans (from Pittsburgh or elsewhere) if it 
acquired any federal savings bank, not necessarily one chartered in Delaware.  But, 
LBH chose to acquire a Delaware bank, and that choice resulted in significant 
benefits: authorization to lend money outside the state in accordance with 
Delaware laws without regard to the other states’ lending restrictions or usury 
laws; fire and police protection; access to courts; and access to schools, health care, 
and welfare benefits for the Bank’s employees.76  Those benefits are “reasonably” 
related to the Bank’s presence in Delaware. 
The Bank next urges that the external consistency test is not satisfied 
because the Delaware bank franchise tax creates both threatened and actual 
multiple taxation.  There is no constitutional prohibition against actual double 
taxation occasioned by two states having different apportionment systems.77  In 
any event, the Bank’s argument leads nowhere because the Superior Court found 
                                                 
76 See Super. Ct. Op., at *10. 
 
77 See Moorman Mfg. Co. v. Bair, 437 U.S. 267, 277-78 (1978); Barclays Bank, 512 U.S. at 318-
19 (citing Container Corp., 463 U.S. at 187-89). 
 
 
33
that the Bank had failed to prove by “clear and cogent evidence”78 precisely what 
income (if any) was taxed by other states.  As earlier explained, other than an 
unsupported one page document purporting to show that $106 million in tax was 
paid to other jurisdictions, nothing in the record establishes actual multiple taxation 
or a significant threat thereof.  Thus, the external consistency requirement is met 
here, because the structural apportionment framework of the Delaware bank 
franchise tax statute reasonably reflects and fairly measures the Delaware 
components of the Bank’s “multi-state” business.  Accordingly, Delaware’s bank 
franchise tax does not violate the Dormant Commerce Clause. 
B.  Due Process Clause Analysis 
 
The Bank also challenges the constitutionality of the Delaware bank 
franchise tax statute under the Due Process Clause of the Fourteenth Amendment.  
For a state to constitutionally tax income generated in interstate commerce, the 
Due Process Clause imposes two requirements: “a ‘minimal connection’ or ‘nexus’ 
between the interstate activities and the taxing state, and ‘a rational relationship 
between the income attributed to the state and the intrastate values of the 
                                                 
78 Moorman Mfg., 437 U.S. at 274 (1978) (“assessment will only be disturbed when the taxpayer 
has proved by ‘clear and cogent evidence’ that the income attributed to the State is in fact ‘out of 
all appropriate proportion to the business transacted . . . in that State,’ or has ‘led to a grossly 
distorted result.’”) (internal citations omitted). 
 
 
34
enterprise.’”79  The Bank argues that Delaware’s taxing of all the Bank’s income 
violates Due Process because no rational relationship exists between the tax 
imposed by Delaware and the income taxed, which, the Bank urges, was earned 
from activities conducted outside of Delaware. 
The United States Supreme Court has held that the requisite nexus between 
the interstate activities and the taxing state is established if the taxpayer avails 
itself of the “substantial privilege of carrying on business” within the taxing state.80  
Sufficient connection has been found to exist where the taxpayer maintains an 
office in the taxing state.81  Here, it is undisputed that the Bank had the requisite 
minimum contacts with Delaware:  the Bank’s home office and the Bank’s sole 
banking office were both located in Wilmington, Delaware.  Those contacts are 
sufficient to satisfy the Due Process minimal connection requirement. 
For the second requirement to be satisfied, there must be a rational 
relationship between the taxed income and the “values connected with the taxing 
                                                 
79 Container Corp., 463 U.S. at 169 (citing Mobil Oil Corp. v. Comm’r of Taxes of Vermont, 445 
U.S. 425, 436 (1980)). 
80 Mobil Oil Corp., 445 U.S. at 436 (citing Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444-45 
(1940)). 
 
81 D.H. Holmes, Ltd. v. McNamara, 486 U.S. 24, 32 (1988); Nat’l Geographic v. Cal. 
Equalization Bd., 430 U.S. 551, 556 (1977).  Despite their similar language, the nexus 
requirements of the Due Process and Commerce Clauses are not identical.  The Commerce 
Clause is more stringent than the Due Process Clause on the state’s taxation power.  See Quill 
Corp. v. North Dakota, 504 U.S. 298, 312-13 (1992).  See also J.C. Penney Nat. Bank v. 
Johnson, 19 S.W.3d 831, 836-37 (1999). 
 
 
35
State.”82  The inquiry is “whether the taxing power exerted by the state bears fiscal 
relation to protection, opportunities and benefits given by the state.”83  The 
privilege of carrying on a business in the state; police and fire protection; 
emergency health services; public utilities; and a safe climate to conduct business 
have been deemed sufficient to support imposition of the tax.84  The Superior Court 
held that “the Bank receives many of Delaware’s benefits and protection, thus 
satisfying this requirement.”85  The record discloses no basis to disturb that finding. 
For these reasons, the Commissioner and the Superior Court correctly 
concluded that the Delaware bank franchise tax, as applied to the Bank, satisfies 
the Due Process requirements imposed by the United States Constitution. 
Abatement of Penalties 
 
Finally, the Bank claims that the Commissioner erred by refusing to abate 
the assessed penalties, which, according to the Bank, totaled $14 million and were 
                                                 
82 Moorman Mfg., 437 U.S. at 272-73 (citing Norfolk & Western R. Co. v. State Tax Comm’n, 
390 U.S. 317, 325 (1968)). 
 
83 J.C. Penney, 311 U.S. at 444. 
 
84 See J.C. Penney, 311 U.S. at 444; Bridges v. Autozone Properties, Inc., 900 So.2d 784, 809 
(La. 2005); Zelinsky v. Tax Appeals Tribunal of State, 801 N.E.2d 840, 848 (N.Y. 2003). 
 
85 Super. Ct. Op., at *11.  In so ruling, the trial court observed that Delaware’s ability to impose a 
tax is not affected by the fact that “the mortgages were originated or approved somewhere else 
nor that the funds for the mortgages came through Pittsburgh.”  Super. Ct. Op., at *12 (citing 
J.C. Penney, 311 U.S. at 444 (holding that “[t]he fact that the tax is contingent upon events 
brought to pass without a state does not destroy the nexus between such a tax and transactions 
within a state for which the tax is an exaction.”)) 
 
 
36
“excessive compared to the activities conducted in the State.”  Before reaching the 
issue of excessiveness, we note that the Bank’s computation of the “amount” of 
penalties as $14 million is factually incorrect.86  The $14 million includes the 
penalties ($4 million) plus the additional tax liability assessed ($10 million), as of 
the date of the Commissioner’s decision (May 20, 2005).87  Thus, the penalties 
imposed totaled $4 million, not $14 million as the Bank claims. 
Turning to the legal merits, the Commissioner assessed penalties under 
Section 1104(e), which provides that “[i]f any banking organization ... shall fail to 
pay any tax due under this chapter on or before the due date, a penalty of 0.05 
percent shall be assessed for each day that the same shall remain unpaid after such 
date.”88  The Commissioner refused to abate the penalties, holding that the amount 
was appropriate “in relation to the activities [the Bank] conducted and the income 
it earned in [Delaware],” and was not excessive even though “the review of the 
Bank’s franchise tax returns for the years at issue did not begin until after March 
                                                 
86 The Superior Court adopted the Bank’s incorrect computation:  “The Commissioner also 
assessed late payment penalties amounting to $14,515,474 for 2000-2003, and also another 
penalty of $5,251.74 for each day after May 20, 2005 that the assessments remain unpaid.”  See 
Super. Ct. Op., at *3.   
 
87 As of the date of oral argument before this Court, the amount of the penalties, exclusive of 
additional tax, was approximately $7.8 million. 
 
88 5 Del. C. § 1104(e).  Chapter 5 contains two other provisions establishing penalties in 
connection with the bank franchise tax (§ 1104(a) and (c)), which are not applicable here. 
 
 
37
2003.”89  Under Section 1114, the Commissioner “is authorized to abate the unpaid 
portion of the assessment of any tax, interest, penalty, additional amount or 
addition to the tax, or any liability in respect therefore, which is ... [e]xcessive in 
amount.”90  The usage of the word “authorized” indicates that the Commissioner 
has discretion whether or not to abate.  The Internal Revenue Code (“IRC”) 
contains a virtually identical abatement provision,91 which has been construed as 
conferring discretionary power to the taxing authority.92 
In considering whether to exercise that discretionary power, the 
Commissioner held that the phrase “excessive in amount” should not be given “an 
expansive meaning that includes some general notion of equitable fairness.”93  
Starting from that premise, the Commissioner mechanically applied the statutory 
percentage rate to the additional tax liability assessed, as of March 1, 2001 (the due 
date for the 2000 tax).  Federal District Courts and the United States Tax Court 
                                                 
89 Comm. Dec., p. 21. 
 
90 5 Del. C. § 1114(a.1) (italics added).  Although the Commissioner is authorized to abate both 
tax assessments and penalties, the Bank is only disputing the Commissioner’s refusal to abate the 
penalties. 
 
91 See I.R.C. § 6404(a)(1).  See also 30 Del. C. § 538 (Chapter 30’s abatement provision, 
virtually identical to the IRC provision). 
 
92 See Matter of Bugge, 99 F.3d 740, 744 (5th Cir. 1996); Wright v. C.I.R., T.C.M. 2004-69, at *2 
(U.S. Tax. Ct. 2004). 
 
93 Comm. Dec., p. 21.  But see Edelson v. C.I.R., 829 F.2d 828, 832 n.4 (9th Cir. 1987) (noting 
that the Commissioner is free to forgive a portion of the tax, should the taxpayers apply for 
“executive clemency”). 
 
 
38
have held that a taxing authority abuses its discretion if it denies a taxpayer’s 
abatement request “arbitrarily, capriciously, or without sound basis in fact or 
law.”94  Here, the record does not disclose any basis in fact for the Commissioner’s 
refusal to abate, because the Commissioner recited no specific facts to support its 
decision.  We recognize that the applicable Delaware statutes (Sections 1104(e) 
and 1114(a), defining the penalty and, respectively, authorizing abatement) afford 
little guidance as to the factors to be considered when assessing (and when 
deciding whether to abate) a bank franchise tax penalty.  The counterpart 
provisions of the IRC and of Chapter 30 (Taxation) of the Delaware Code are 
instructive in this regard, however.95 
Both Section 6651(a) of the IRC and Section 534 of Chapter 30 distinguish 
between penalties for failure to file a return that results in failure to pay the tax, 
and penalties for failure to pay additional tax assessed following the taxing 
                                                 
94 Beall v. U.S., 335 F.Supp.2d 743, 748 (E.D. Tex. 2004) (emphasis added); Dadian v. Comm’r, 
2004 WL 1118291 at *3 (U.S. Tax Ct. 2004) (citing Woodral v. Comm’r, 112 T.C. 19, 23 (U.S. 
Tax Ct. 1999)).  State courts have also specifically held that a tax authority’s refusal to abate 
penalties may not be arbitrary.  See, e.g., J.M. Smucker, LLC v. Levin, 865 N.E.2d 866, 869 
(Ohio 2007); Patel v. Director, Div. of Taxation, 13 N.J. Tax 509, 515 (N.J. Tax. Ct. 1993); 
Norris v. Commonwealth, 625 A.2d 179, 182-83 (Pa. Commw. 1993). 
 
95 It is proper to look at the general taxation principles contained in the Delaware Code, because 
several provisions in Chapter 5 (Banking) specifically cross-reference Chapter 30 (Taxation).  
Moreover, this Court has looked at similar federal tax provisions when a Delaware tax statute 
was ambiguous.  See Director of Revenue v. CNA Holdings, Inc., 818 A.2d 953, 957-59 (Del. 
2003); Logan v. Davis, 191 A.2d 1, 5 (Del. 1963). 
 
 
39
authority’s review of a filed return.96  Failure to file a return (which did not occur 
here) results in higher penalties, which are calculated to run from the day that the 
return should have been filed.  In contrast, where a return is filed and additional tax 
is assessed, a penalty is due only if the taxpayer fails to pay the balance within a 
prescribed period of time from the assessment.97   
Here, the Commissioner assessed penalties at a daily rate of 0.05% per day, 
running from March 1, 2001, when the 2000 bank franchise tax first became due.  
To assess penalties from March 2001, in a case where no additional tax liability 
was assessed until October 2003, appears arbitrary.98  The Commissioner insists 
that it was not required to notify the Bank of the deficiency any sooner than it did, 
because the statute contains a three year period of limitations, which was 
observed.99  But the statute of limitations is not the only factor informing the sound 
exercise of discretion.  30 Del. C. § 521(a) directs that “[a]s soon as practicable 
                                                 
96 See I.R.C. § 6651(a) and 30 Del. C. § 534. 
 
97 Regrettably, 5 Del. C. §  1104(e) makes no such distinction. 
 
98 The Commissioner imposed penalties from the due date of the tax for each year in question, 
not from the date of the notice of assessment.  That computation finds no support in Chapter 30 
or the IRC, which provide that, where additional tax is imposed, both penalties and interest may 
be imposed, but only from the date of the notice of the proposed assessment and only if the 
additional tax assessed is not paid within a certain period of time following that notice.  See 30 
Del. C. §§ 533 and 534 and I.R.C. §§ 6601 and 6651.  We note that only “penalties” may be 
imposed under Chapter 5 because Chapter 5 does not mention “interest.”  The Commissioner, 
therefore, correctly did not assess interest. 
 
99 See 5 Del. C. § 1111. 
 
 
40
after any return is filed, the [tax authority] shall examine it to determine the correct 
amount of tax.”100  Here, the Commissioner’s office did not object to the Bank’s 
2000 Franchise Tax Return until nearly three years after that return was filed.  
Indeed, not until the Commissioner’s October 6, 2003 letter was the Bank told that 
its Returns for the tax years 2000-2002 were incorrect.  Only at that time was the 
Bank’s liability recalculated based on the disallowance of the line 4(b) deduction. 
The Commissioner rejected without explanation the Bank’s contention that 
the three year administrative delay justified an abatement of penalties.  Before this 
Court, the Commissioner claims that the delay was attributable to the Bank’s 
failure to submit the requested documentation in support of the line 4(b) deduction.  
That argument is flawed.  The Bank did provide certain apportionment schedules, 
and the Commissioner and the Superior Court found that those schedules were 
insufficient to support a line 4(b) deduction.  But, during oral argument before this 
Court, the Commissioner conceded that the submission of any documentation, 
however sufficient, would have been “irrelevant,” because the line 4(b) deduction 
was simply not available to the Bank as a matter of law.101  Accordingly, for 
penalty abatement purposes, the Commissioner may not rely on the Bank’s failure 
to provide sufficient supporting documentation. 
                                                 
100 30 Del. C. § 521(a) (emphasis added). 
 
101 As explained above, that deduction applies solely to entities that have out-of-state branches or 
subsidiaries.  The Bank had no such branches or subsidiaries during the relevant period. 
 
 
41
Finally, Chapter 30 and the IRC provide that penalties should not be 
imposed when the failure to pay the additional tax liability assessed is “due to 
reasonable cause and not due to willful neglect.”102  The United States Supreme 
Court held that “reasonable cause” exists where a taxpayer demonstrates that it 
exercised “ordinary business care and prudence,” and that “willful neglect” means 
“conscious, intentional failure or reckless indifference.”103  Although it is for the 
Commissioner, not this Court, to determine whether the Bank met these 
requirements, it is noteworthy that:  (i) the Bank filed its original Franchise Tax 
Returns consistent with the practice of its predecessor; (ii) the timeliness of the 
Bank’s filings is undisputed; (iii) the Bank requested, and relied upon, the opinion 
of an independent tax advisor (Ernst & Young) before amending its returns in 
August 2004; (iv) the Bank later obtained the opinion of a second independent tax 
advisor (PricewaterhouseCoopers); (v) the Bank contested in good faith the 
assessment of additional tax liability, before the Commissioner, the Superior Court, 
and this Court; and (vi) the Bank’s legal position with respect to the original and 
the amended Franchise Tax Returns was not frivolous, and the filing of those Tax 
Returns was not fraudulent. 
                                                 
102 See I.R.C. § 6651(a)(3) and 30 Del. C. § 534(b)(2). 
 
103 Director of Revenue v. J.E. Rhoads & Sons, Inc., 628 A.2d 1388, 1390 (Del. 1993) (citing 
United States v. Boyle, 469 U.S. 241, 245-46 (1985). 
 
 
42
Because the Commissioner failed to consider any of the above-described 
circumstances, we are constrained to conclude that the Commissioner abused its 
discretion by refusing to abate, in an appropriate way, the penalties assessed.  It 
follows that, in affirming the Commissioner’s decision, the Superior Court legally 
erred.  Therefore, the penalty provision of the Superior Court order will be 
reversed, and the case will be remanded with instructions that the Superior Court 
remand the case to the Commissioner to reconsider the Bank’s request for 
abatement of penalties, in accordance with this Opinion. 
CONCLUSION 
 
For the reasons set forth, the judgment of the Superior Court is affirmed in 
part, and reversed in part and remanded for further proceedings in accordance with 
this Opinion.