Title: Crocker Equip. Leasing v. Dept. of Rev.

State: oregon

Issuer: Oregon Supreme Court

Document:

838 P.2d 552 (1992)
314 Or. 122
CROCKER EQUIPMENT LEASING, INC., Respondent,
v.
DEPARTMENT OF REVENUE, State of Oregon, Appellant.
OTC 2973; SC S38059.

Supreme Court of Oregon, In Banc.
Argued and Submitted March 3, 1992.
Decided August 20, 1992.
Marilyn J. Harbur, Asst. Atty. Gen., Salem, argued the cause for appellant. With her on the briefs was Dave Frohnmayer, Atty. Gen., Salem.
Roy E. Crawford, of Brobeck, Phleger & Harrison, San Francisco, Cal., argued the cause for respondent. With him on the brief was Craig R. Berne, San Francisco, Cal.
GRABER, Justice.
The Department of Revenue (Department) appeals from a judgment of the Oregon Tax Court concerning Oregon corporate excise taxes owed by taxpayer Crocker Equipment Leasing, Inc. (CELI), a California corporation, for the years 1978 through 1980. CELI challenged the Department's assessment, contending that the formula that the Department used to apportion CELI's Oregon business income did not fairly represent the extent of its business activity in this state. The Tax Court agreed with CELI and ordered a refund. Crocker Equipment Leasing, Inc. v. Dept. of Rev., 12 OTR 16 (1991). We review de novo, ORS 305.445, 19.125(3), and affirm the judgment of the Tax Court.
CELI and the Department stipulated to the following facts:[1]
"1. During the three tax years (calendar years 1978, 1979, and 1980) Crocker Equipment Leasing, Inc. ("CELI") was a *553 California Corporation engaged in the business of owning, leasing and financing tangible personal property. CELI was a 100% owned subsidiary of Crocker National Bank, a U.S. chartered national bank engaged in virtually all aspects of normal banking activities. Crocker National Bank was headquartered in California. Crocker National Bank was a subsidiary of Crocker National Corporation, a holding company incorporated in the laws of Delaware and registered under the Bank Holding Company Act of 1956, as amended, 12 U.S.C. §§ 1841 et. seq. Both Crocker National Corporation and Crocker National Bank owned other subsidiaries * * *.
"CELI obtained new leases both (1) by purchase from other corporations such as leasing companies or banks that originated a lease transaction, and (2) by originating a new lease itself. CELI maintained its principal offices in California, and did not have an office, telephone listing, or mail drop in Oregon. CELI did not have any employees based in Oregon, but on occasion a CELI employee *554 from California or the Seattle office of CELI may have visited a client in Oregon.
The parties also incorporated into their stipulation a number of documents, including CELI's California corporate franchise tax returns for tax years 1978, 1979, and 1980 and Forms 10-K (Annual Reports under Sections 13 or 15(d) of the Securities Exchange Act of 1934) of Crocker National Corporation (Crocker) for 1978, 1979, and 1980.
Generally, the Uniform Division of Income for Tax Purposes Act (UDITPA), ORS 314.605 to 314.670, prescribes the method for determining how much of a taxpayer's national or worldwide income is allocable to its Oregon business activities. Pacific Coca-Cola Bottling Co. v. Dept. of Rev., 307 Or. 667, 669 & n. 2, 773 P.2d 1290 (1989). In the relevant tax years, ORS 314.650 provided:
In Twentieth Century-Fox Film v. Dept. of Rev., 299 Or. 220, 224, 700 P.2d 1035 (1985), this court explained how the three-factor formula operates:
The statutory structure applicable in this case is slightly more complicated, because the parties agree, as do we, that the unitary business of which CELI is a part is a financial organization. Financial organizations are excluded, by ORS 314.615, from the coverage of UDITPA. ORS 314.615 provides in part:
ORS 314.280 provides for a method of apportioning income for taxpayers that are financial organizations and authorizes the Department to adopt regulations. Notwithstanding the legislature's express exclusion of financial organizations from UDITPA, the Department, by regulation, applies the UDITPA three-factor apportionment formula to financial organizations, except that a "gross revenues" factor is used in place of the "sales" factor. OAR 150-314.280(E). In this court, taxpayer does not challenge the Department's authority to promulgate OAR 150-314.280.[3]
To compute each apportionment factor, OAR 150-314.280(F) incorporates by reference the UDITPA methodology used to determine the property (ORS 314.655), payroll (ORS 314.660), and sales (ORS 314.655) factors of nonfinancial businesses. In this case, the parties agree on all factors except the property factor. The property factor is computed as follows:
CELI maintains that intangible property must be included in the property factor to avoid distortion. Its position rests primarily on the nature of the unitary business. CELI asserts: Crocker's business is banking; its basic function is to loan money on which it earns interest; about 98 percent of Crocker's earning assets[4] are intangibles; *556 and even CELI's leases of equipment represent an alternative form of financing although they involve tangible property.
The Department did not include intangibles in the property factor. The Department asserts that using only tangible property does not produce a disproportionate result, because the gross revenues factor reflects the interest income earned by intangibles.
ORS 314.280, which applies to financial organizations, provides an avenue of relief for taxpayers who allege that the statutory formula does not fairly represent their Oregon business activity. ORS 314.280 provides:
In the relevant tax years, OAR 150.214.280(I) incorporated, for financial organizations, the regulation for nonfinancial businesses, OAR 150-314.670(A), which was promulgated under ORS 314.670 (1977). OAR 150-314.670(A) provided in part:
In the present case, the Tax Court found that "use of only tangible property in the property factor in this case results in a disproportionate apportionment of income to Oregon." Crocker Equipment Leasing v. Dept. of Rev., supra, 12 OTR at 21. The Tax Court also found that CELI's suggested alternative of including intangibles in the property factor was reasonable, because *557 it "results in an apportionment which fairly and accurately reflects plaintiff's business activity within the state." Id. at 23.
Taxpayer has the burden of proving, by a preponderance of the evidence, that the statutory apportionment formula does not fairly represent the extent of taxpayer's business activity in Oregon. ORS 305.427; ORS 314.280; Twentieth Century-Fox Film v. Dept. of Rev., supra, 299 Or. at 225, 237, 700 P.2d 1035. In Twentieth Century-Fox, this court discussed what a taxpayer seeking to deviate from the statutory three-factor apportionment formula must prove:[6] First, the taxpayer must demonstrate that "the statutory formula as a whole does not `fairly represent the extent of the taxpayer's business activity in this state.'" 299 Or. at 233, 700 P.2d 1035. Second, the taxpayer must establish that its alternative method of allocating income is reasonable. Ibid.
The first question, then, is whether taxpayer demonstrated, by a preponderance of the evidence, that the statutory formula as a whole does not fairly represent the extent of its business activity in Oregon. Taxpayer presented the testimony of Sandra B. McCray, whom it qualified as an expert on state taxation of the banking industry.[7] She testified that, based on her knowledge of banks in general, using a property factor that omits intangibles does not reasonably reflect how the income is generated for a bank, because a bank's income is generated mainly through intangibles. McCray further testified that about 98 percent of Crocker's earning assets[8] are intangibles and that excluding intangibles from the denominator of the property factor in this case did not fairly reflect taxpayer's business activity in Oregon. She testified that excluding intangibles in this case yielded a "grossly distorted" result.
We find in accordance with McCray's testimony. There was no evidence to the contrary.
The Department counters that using only tangible property in the property factor does not produce a disproportionate result, because the gross revenues factor adequately reflects the interest income earned by intangibles.[9] We disagree. Each factor in the formula is weighted equally; the three-factor formula "`has the built-in assumption that one-third of the net income is derived from the use of property, one-third from services and one-third from selling.'" 12 OTR at 21 n. 4 (quoting W. Beaman, Paying Taxes To Other States 3.15 (1963)). Including interest income from intangibles in the gross revenues factor does not correct the extremely disproportionate representation of business activity caused by excluding intangibles from the property factor. As the stipulated facts show, exclusion of intangibles from the property factor increases that factor about 16 times and increases the average of the three apportionment factors about 6 times.
We agree with the Tax Court that "[t]he unitary income which is being apportioned is the income of a large bank, 98 percent of which is attributable to loans or intangible property." 12 OTR at 21. To exclude that 98 percent from the property factor does not fairly represent CELI's as part of the unitary Crocker organization's, business activity in Oregon. The Department's formula as a whole does not fairly represent *558 the extent of CELI's business activity in this state.
The second question is whether CELI's proposed alternative of including intangibles in the property factor is a reasonable method of apportioning income. Reasonableness in this context has three components:
The first component of our inquiry is whether taxpayer's proposal fairly represents business activity and, if applied uniformly, would result in taxation of neither more nor less than 100 percent of the business's activity. McCray testified that including intangibles in the property factor yields a property factor that bears a realistic relationship to how the income is earned. CELI also introduced the testimony of James Brown, a Department employee, to the Multistate Tax Commission, in which he agreed that, for financial organizations, intangibles should be included in the property factor in order to reflect properly the business activity of banks. We find that including intangibles in the property factor properly reflects business activity. The Department does not dispute that taxpayer's proposed formula, if applied uniformly, would result in taxation of neither more nor less than 100 percent of the business's activity.
The second component of the inquiry into the reasonableness of taxpayer's proposal is whether the division of income creates or fosters lack of uniformity among jurisdictions. McCray testified that, in the relevant tax years, state taxation of banks was "chaos," with states using 32 different methods of apportioning state banks' income. McCray further testified that many states did not apportion income of banks at all and that many had no formal guidelines. She stated that the Multistate Tax Commission had proposed a regulation, which would include intangibles in the property factor, as a move toward uniformity. CELI also introduced evidence that California, Crocker's domicile, included intangibles in the property factor. We find that using taxpayer's proposed formula would not create or foster any greater lack of uniformity among jurisdictions than already exists, and might even reduce it somewhat.
The third component of the inquiry is whether including intangibles reflects the economic reality of the business activity engaged in by the taxpayer in Oregon. Including intangibles would reflect economic reality for the same reasons that excluding intangibles fails to reflect economic reality.
CELI has met its burden of proving both that the Department's formula is inadequate and that CELI's alternative formula is reasonable. We so find.
The judgment of the Tax Court is affirmed.
[1]  Because of the parties' stipulation, our fact-finding role in this case is limited. In any event, this court's factual decisions as a finder of fact on de novo review of the record made in the Tax Court have no precedential value. United Telephone Co. v. Dept. of Rev., 307 Or. 428, 431, 770 P.2d 43 (1989); Bend Millwork v. Dept. of Revenue, 285 Or. 577, 581-82, 592 P.2d 986 (1979).
[2]  During the years 1978 through 1980, 12 CFR § 7.7376 authorized an operating subsidiary of a national bank to "lease property."
[3]  Taxpayer did challenge the validity of those regulations in its complaint to the Tax Court. In responding to the Department's appeal, however, taxpayer does not argue for affirmance on this alternative ground, and we therefore assume the validity of the regulations.
[4]  CELI uses the term "earning assets" to refer to property that produces income, such as loans and equipment that CELI leases to others. Other property, such as cash on hand and bank premises, is not included in CELI's use of the term "earning assets." If all property is considered, tangible property represented about 3 percent of Crocker's property in the relevant tax years.
[5]  ORS 314.670 and OAR 150-314.670 have been amended to permit these alternative methods of allocation and apportionment "only where unusual fact situations (which ordinarily will be unique and nonrecurring) produce results which violate a taxpayer's rights under the constitution of Oregon or of the United States." OAR 150-314.670. That amendment is not retroactive, and we express no view concerning it.
[6]  Twentieth Century-Fox Film v. Dept. of Rev., supra, interpreted the UDITPA formula for nonfinancial businesses. As noted above, the Department's regulations for financial organizations incorporate the UDITPA formula, and we assume the validity of those regulations in this case.
[7]  McCray had worked for the Multistate Tax Commission to develop a new method for state taxation of banks. She also has been a member of the Colorado State Banking Board, a Director of the New York Legislative Tax Study Commission, an author of the report by the Federal Advisory Commission on Intergovernmental Relations on state taxation of banks, and a consultant to the states of Massachusetts, Nevada, and New York concerning state banking laws.
[8]  McCray used the term "earning assets" in the same sense as CELI does. See note 3, supra.
[9]  The gross revenues factor includes "all income, including interest, fees, service charges, discounts, gains from sale of assets and miscellaneous income." OAR 150-314.280(E).