1 Defendants note that the current Director , Brian Hamer, may be substituted for Bower, who is the former Director. SIXTH DI VISI ON January 12, 2007 No. 1-03-1160 THE MEAD CORPORATION, an Ohio ) Appeal from the Corporation, ) Circuit Court of ) Cook County Plaintiff -Appella nt, )

) v. ) No. 00 CH 7854 ) THE DEPARTMENT OF REVENUE, ) Honorable GLEN L . BOWER, Director of the ) Alexander P. White, Department of Revenue, and JUDI TH BAAR ) Judge Presi ding. TOPI NKA, Tre asurer

of the Sta

te of I llinois, )

) Defendants-Appellees. ) PRESID ING

JUSTICE

FIT ZGERAL D SMITH deliver

ed the opi nion of the

court: Plaintiff Mead Corporation, an Ohio corporation (Mead or plaintiff), a ppeals three orders of the circuit court concerning the c lassification and calculation of sales gain repor ted on its 1994 Illinois tax return, granting judg ment in favor of defendants I llinois Department of Revenue (Department), Glen L . Bower, Director of the I llinois Department of Revenue, 1 and Judith Baar Topinka, Treasurer of the State of I llinois (collectively, defenda nts). Mead filed a combined unitary Illinois income

tax return

for the 1 994 tax y

ear, inc luding Me ad Data Central, Inc ., Lexis, Inc., and Nexis, I

nc. (collectively , Lexis/Nexis), as members of its unitary business group, and including in its Illinois combined apportionable business income the 1994 income ea rned by Lexis/Nexis, but excluding the gain of more than $1 billion from the sale of Lexis/Nexis that ye ar. Mea d also inc luded its g

ross rec eipts from the sale of intere st-bear

ing fina ncial inst ruments1-03-1160

-2-

in its sales factor denominator of the combined apportionment formula. The De partment determined that the Lexis/Nexis sale gain constituted apportionable business income and the net income, rather than the gross rec eipts from the sale of the financial instruments, should be used to compute Mead's sales factor denominator. Af ter the Department issued notices of deficiencies for more than $4 million in income tax and interest, which Mead paid under protest, Mead challenged the Department' s classification of the sales gain as apportionable business income and its calcu lation of t he sales factor denomina

tor. We af

firm. This case presents a voluminous record. However , the facts, as set forth below, are essentially undisputed. Mead is an Ohio corporation which transacts business in Illinois. In 1968, when Mead was a pr oducer a nd seller of paper , packa

ging, and scho ol and off

ice suppl ies, it pur

chased D ata Corpora tion for $ 6 million. A

t the time, Data Cor

poration was deve loping, a

mong othe

r things , ink jet printing technologies and a computerized full text information retrieval sy stem. The latter, by 19 73, evolv ed into L exis/Nexis. O ver the y ears, Me ad made c apital contribution s to Lexis/Nexis, which become profitable only by the end of the 1970s. During its ownership of L exis/Nexis, Me ad trea ted L exis/Nexis va

riously as a cor porate division or as a subsidiary. I n 1980, Lexis/Nexis was merged into Mead as a division; in 1985, Lexis/Nexis was reincorporated separa tely. I n December 1993, Mead and L exis/Nexis merged again, with Lexis/Nexis again becoming a division of the parent company . During the y ears of

owners hip, Mead co ntin ued to appro ve maj or capi tal ex pendi tures for Lexi s/Nex is, i nclud ing a 1984 expansion of the Lexis/Nexis computer center and central proc essing units. In 1993, at the1-03-1160

-3-

time of the

second me

rger, Mead' s board of

directors appro ved a ca

pital expen

diture of nearly $13 million for the improvement of Lexis/Nexis' search sy stem. Again, the following y ear, the Mead boa rd approved sign

ificant e xpenditure s for L exis/Nexis. Mead and Lexis/N exis mainta

ined sepa rate da y- to-day business o

perations, and the

y di d not share personnel or make joint purchases. Since 1980, Lexis/Nexis had its own building about 15 miles from Mead's Day ton headquarters. There was no ce ntralized manufacturing or warehousing of products, and Mead a nd Lexis/Nexis were described as having different corporate cultures. There wer e no favorable intercompany transactions. However, Mead made nightly a cash sw eep of Lexis/Nexis ba nk acco unts, inve sting the

funds with

benefit s accru

ing to Lexis/Nexis, but in a manner decided by Mead. Since 1988, the Department had asserted that Mead and L exis/Nexis were a unitary business. Although Mead disagreed, to settle disputed audit finding s, Mead included Lexis/Nexis in its unitary business group f rom 1988 through 1994. According to Mead' s 1993 annual report, Mead was not only "one of the world's larg est manufacturers of paper," and a leader in packaging, but it was " the developer of the world's leading electronic information retrieval ser vices for law, patents, acco unting, fin ance, news and b usiness i nformation ." Lexis/N exis was inc luded as one of Mea d's business seg

ments, but

not in Mea

d's disc ussion of i

ts "investees." Mead filed a 10-K f orm with the Securities and Exchange Commission (SEC) for the year ending December 31, 1993, in which Mead de scribed itself as a company engaged in the manufacture and

sale of p aper an

d wood pro ducts, an

d school a

nd offic e supplie s, and en gage d in electronic publishing.1-03-1160

-4-

In May 1994, Mead announced its plan to sell Lexis/Nexis, stating in its press release that it had "grown" L exis/Nexis "since 1968 from a small legal database into the world's pre mier provider of online legal information and the pioneer in computer-assisted news retrieval." On Decemb er 2, 199 4, Mead so ld the ass ets of L exis/Nexis to R eed Else vier, plc , for approximately $1.5 billion. In describing the divestiture in its 1994 annual repor t, Mead again stated that had "grow[n] this business" but decided to use approximately $350,000 of the gain to buy back stock. Mead als o used the

procee ds to redu

ce its sho rt- and long-ter

m debt lev els. For the 1 994 tax y

ear, Me ad and its

subsidiar ies filed an I llinois com

bined unit

ary income tax return, in which it listed Lexis/Nexis as a unitary subsidiary , as it had done from 1988-93. Mead reported its base income as $1,074,709,139 and its Illinois sales in 1994 as $338,309,666, of which Lexis/N exis contri

buted $46 ,912,518. Mead re ported a s nonbusine ss income $1,056,00 1,948 in g ain from t he sale o f its L exis/Nexis div ision. The

reporte d nonbusin ess income was a gain on "g oodwill" realized from the Lexis/Nexis sale. Mead also included Lexis/Nexis' assets in its Illinois apportionment factors on its 1994 I llinois return. Mead included in its computation of the denominator of the sales apportionment factor $4,846,382,229 as gros s recei

pts from the sale of

financi al instruments, of w hich $1,9 67,953.61 was inter est income e arned by

those inve stments. The Department audited Mead's I llinois income tax returns for the 1993 and 1994 tax years a nd issued two notices of deficiencies for the 1994 tax y ear. The deficiency

notices resulted from two audit findings: (1) the $1,056,001,948 gain fr om the Lexis/Nexis sale was improperly classified a s nonbusiness income and (2) Mead could include only the $1,967,953.611-03-1160

-5-

that was i nterest i ncome in i

ts sales f actor de nominator

rather than the $ 4,846,382 ,229 gr oss receipts from the sale of financial instruments. The Depa rtment found that Mead owed $3,149,22 2 in Il linois income tax and $ 1,049,017 in intere st. Mead protested, but paid the amount into the protest fund (see 30 I LCS 230/1 et seq. (West 2002)). In January 2001, Mead filed an amended verified complaint, seeking injunctive and de clarat ory relief . In the am ended compl aint, Mead ch allen ged the Depart ment's classification of the gain from the L exis/Nexis sale as apportionable business income and the Department's calculation of its sales factor denominator. In March 2002, proce edings on the former issue, which included the testimony of numerous witnesses, were held before the c ircuit court, while the latter issue was decided on the parties' cross-motions for partial summary judgment. As to the latter issue, the computation of the sales factor, the circuit court initially granted Mead's motion, and the Depa rtment filed a motion for reconsideration. On December 2, 2002, the c ourt issued a memorandum decision, judgm ent an d orde r, reve rsing t he part ial su mmary jud gment i n Mead 's favo r, den ying Mead's motion for partial summary judg ment, and granting the Depar tment's motion for the same. On March 18, 2003, the court issued a memorandum decision, judgment a nd order deciding the classification issue. I n its order, the court found, among other things, that Mea d and Lexis/Nexis were not unitary , the sale of Lexis/Nexis represented a liquidation in the business of electronic publishing, a

nd, beca use the pr operty disposed o f in the liq

uidation w as "ess ential to the taxpay

er's r egular trade or operati ons," the

gain the refrom was appor

tionable business income.1-03-1160

-6-

On March 25, 2003, the cour t issued a final judg

ment orde

r, findin g that a ll issues in plaintiff's first amended verified complaint had bee n resolved in favor of defendants (based on the findings of fact and conclusions of law set for th in the orders of December 2, 2002, and March 18, 2003) and that no remand to the Department wa s necessary . The court dissolved preliminary injunctions that had bee n entered in 1999 and 2001, ordered judgment to be e ntered in defendants' favor in the amount of $4, 238, 221, repr esenting the 1999 and 2000 pay ments by plaintiff made under protest, ordered the State Trea surer to transfer the protest pay ments from the protest f und to the a

ppropria te state f und, and s tated tha

t the orde r repre sented a

complete disposition

of all issu

es. Mead app eals from the Dec ember 2, 2002, and March 18 and 25, 20 03, orde rs. On appeal, Mead first contends that the gain f rom the 1994 sale of Lexis/Nexis should be allocated rather than classified as apportionable Illinois income. Initially , we note that the parties appear to ag ree on the standard of review. B oth agree that the c ircuit co

urt hear d substant

ial testimony a

nd conside

red docu ments and

stipulate d facts, but th at, f or the most p art, the f

actsof thi s cas e wer

e und isputed. T

he pa rtie s fur ther reco gniz e that, where the fact finder examines the leg al effect of a given set of f acts, it decides a mixed question of law and fact which is subject to an intermediate standar d of review. See Carpetland U.S.A., I nc. v. Illinois De

partmen t of Employ

ment Secu

rity , 201 Ill. 2d 351, 369, 776 N.E.2d 166 (2002); City of Belvidere v. Illinois State Labor

Relations Board , 181 Ill. 2d 191, 205, 692 N.E.2d 29 5 (1998). Under su ch circ umstance s, the dec ision is bas ed on fac t-finding that is inseparable from the application of law to fact a nd is reviewed under a clearly erroneous1-03-1160

2 The Department notes that, starting in 1999, a single fa ctor apportionment method based solely on sales has bee

n applied. See 35 IL CS 5/304(h), 1501(a)(27) (West 2002).

-7- standard. Carpetland U.S.A., Inc. , 201 Ill. 2d at 369; see AFM Messenger Service, I nc. v. Department of Emp loy

ment Secu

rity , 198 Ill. 2d 380, 391, 763 N.E.2d 272 (2001). This standard is largely deferential to the decision maker. AFM Messenger Service, I nc. , 198 Ill. 2d at 395; Zebra Technologies Corp. v. Topinka , 344 Ill. App. 3d 474, 480, 799 N.E.2d 725 (2003). Under the clearly

erroneous standard, a finding of the lowe r court may be

reversed only

if, after careful review of

the entire record in light of the applicable r ule of law, the reviewing court is left with the "'definite and firm conviction'" that the finding is in error. Carpetland U.S.A., Inc. , 201 Ill . 2d at 369, q uoti ng AFM Messenger Service, I nc. , 198 I ll. 2d at 39 5; Zebra Technologies Corp. , 344 Ill. App. 3d at 481. Purely factual findings are entitled to defer ence and are reversed only

if they are

contrary to the manifest weight of the evidence ( Carpetland U.S.A., Inc ., 201 I ll. 2d at 36 9; Zebra Technologies Corp. , 344 Ill. App. 3d at 480), while pure questions of law are reviewed de novo ( Carpetland U.S.A., Inc. , 201 I ll. 2d at 36 9; Zebra Technologies Corp. , 344 I ll. App. 3d

at 480), g

iving de ferenc e to the De partmen t's inte rpreta tion of its governing statutes and its regula tions (see Automatic Data Processing, I nc. v. Department of Revenue , 313 Ill. App. 3d 433, 443-44, 729 N.E.2d 433 (2000)). The Illi nois Income Ta x Act (Act) p rovid es tha t a corp orate t axpa yer conduc ting a multistate business i

n Illi nois use th e formula

apportionment meth

od of taxat

ion. 35 I LCS 5/304(a) (West 2002) 2 ; Automatic Data Processing, I nc. , 313 Ill. App. 3d at 438-39. Under the formula s et forth i

n section 304(a), three f

actors, which ar

e calcu lated in f raction s, were

used to1-03-1160

-8-

apportion income: Illinois prope rty in propor tion to all property ; Illin

ois pay roll in pro portion to all pay roll; and I llinois sal es in prop ortion to a ll sales. 3 5 IL CS 5/304(a ) (West 200 2); Automatic Data Processing, I

nc. , 313 I ll. App. 3d

at 439. Th e sales f

actor wa s double w eighte d. 35 ILCS 5/304(a) (West 2002 ); Automatic Data Processing, I nc. , 313 Ill. App. 3d at 439. The Act defines business income as "income ar ising from transactions and activity in the regular course of the taxpay er's trade or business," which include s "income from tangible and intangi ble prope rty if the ac quisition, manage ment, and disposition

of the pr operty constitute integral parts of the taxpay er's regular tra

de or business." 35 ILCS 5/1501(a)(1) (West 2002); see also Texaco-Cities Service Pipeline Co. v. McGaw , 182 Ill. 2d 262, 267, 695 N.E.2d 481 (1998). Because all of a business's income is pre sumed to be "business income" (see Borden, Inc. v. Department of Revenue , 295 I ll. App. 3d 1001, 1010 , 692 N.E. 2d 1335 (1 998)), a n "entity claiming that its inc ome is nonb

usiness income bea

rs the bur den of cl early

proving this fact " ( Texaco-Cities , 182 Ill. 2d at 268). Mead contends that the income from the L exis/Nexis sale was nonbusiness income, subject to allocation rather than apportionment, and that apportionment was unconstitutional. The Department counters that apportionment here pa sses constitutional muster because the requisite nexus to I llinois and

rationa l relationship to Me ad's bu siness activities in I llinois existed. We agree. Under the United States Constitution, the taxpayer must have " 'some minimum connection' " to the taxing body and the tax must be " 'rationally related to "values connected with the t axing [s] tate.." ' " Hercules, Inc. v. D epartment of Revenue , 324 Ill. App. 3d 329, 335,1-03-1160

-9-

753 N. E.2d 4 18 (20 01), q uoti ng Quill Corp. v. North D akota , 504 U.S. 298, 306, 119 L. Ed. 2d 91, 10 2, 112 S. Ct . 1904 , 1909 -10 (1 992), quot ing Moorman M anufacturing Co . v. Bair , 437 U.S. 267, 273, 57 L. Ed. 2d 197, 204, 98 S. Ct. 2340, 2344 (1978). The due process and commerce clauses of the United States Constitution prohibit a state from taxing value earne d "outside it s borders" ( Home Interiors & Gifts, Inc. v. Department of Reve nue , 318 Ill. App. 3d 205, 2 10, 74 1 N.E. 2d 998 (2000 ), cit ing Allied-Signal, Inc. v. Dire ctor, Division of Taxation , 504 U.S. 76 8, 119 L . Ed. 2d 533 , 112 S. Ct. 22 51 (1992) ; Hormel Foods Corp. v. Zehnder , 316 Ill. A pp. 3d 1200 , 1203, 738 N.E.2d 14 5 (2000)) , but inste ad requi re that there be " ' "some definite l ink, some m inimum co nnection, b etween a state a nd the *** t ransaction i t seeks to t ax" ' " ( Hercules, Inc. , 324 Ill . App. 3d at 3 36, qu otin g Quill Corp. , 504 U.S. at 306, 119 L. Ed. 2d at 102, 1 12 S. Ct. at 1909, quot ing Miller Brothers Co. v. Mary land , 34 7 U. S. 340 , 34 4-4 5, 9 8 L. Ed. 744, 74 8, 74 S. Ct. 53 5, 539 (19 54)). Sta tes are permitte d, howeve

r, to tax the

multistate income of a nondomiciliary corporation where such minimal connection exists between the taxing sta te and the corpora tion's bu siness activities a nd where a rational relat

ionship exist s betwee n " 'the income a ttributed to the taxing

State and the intra state va

lue of the corpora te business. ' " Hercules, Inc. , 324 Ill . App. 3d at 3 36, qu otin g Allied-Signal, Inc. , 504 U.S. at 772, 119 L. Ed. 2d at 542, 112 S. Ct. at 2255. Further, the taxpay er has " 'the distinct burden of showing by c lear and cogent evidence that [the state tax] results' in the taxation of 'extraterritorial values.' " Hercules, Inc. , 324 Ill . App. 3d at 3 36, qu otin g Container Corp. of America v. Franchise Tax Board , 463 U.S. 159, 164, 77 L. Ed. 2d 545, 554, 103 S. Ct. 2933, 2939 (1983). A state' s apporti onment of income of

a multista

te nondomi ciliary

corpora tion from a1-03-1160

-10-

capital or nontangible transaction is constitutional in two circumstances: where there is a unitary business relationship between the pay or and the payee or where the intangible asse t served an operational rather than an investment function. Hercules, Inc. , 324 I ll. App. 3d at 336; se e also Allied-Signal, Inc. , 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263. Under the unitary relationship test, a single state may tax all the income earned and apportioned, even where a business has subsidi aries, d ivisions, o r common ownership of other businesse s that ope

rate in different jurisdictions, if the businesses have common manager ial or operational resources that "produce econom ies of scale an d a substant ial sharing of values." Hercules, Inc. , 324 Ill. App. 3d at 336; see also Container Corp. of America , 463 U.S. at 179, 77 L. Ed. 2d at 562, 103 S. Ct. at 2947. Under the operational function test, even where no unitary rela

tionship exists, a state may apportion income when the capital transaction serves a n operational function rather than an investment function. Hercules, Inc. , 324 Ill. App. 3d at 337, see also Allied-Signal, Inc. , 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263. There, the releva nt inquiry focuses on the " 'objective charac

teristics of the asset's use and its relation to the taxpay er and its activities within th e taxing St ate.' " Hercules, Inc. , 324 Ill . App. 3d at 3 37, qu otin g Allied-Signal, Inc. , 504 U.S. at 785, 119 L. Ed. 2d at 550, 112 S. Ct. at 2262. Mead doe s not disput

e that L exis/Nexis ha

d the req uisite con nection, or nexus, w

ith Illinois. Rather, it contends that taxation of the intangible income, including the gain on goodwill, from the Lexis/Nexis sale was unconstitutional because Mea d and Lexis/Nexis were not unitary (as the c ircuit court found) and because its ownership of L exis/Nexis did not serve an1-03-1160

-11-

operational function, but merely an investment function. In response, the D epartment argues that the cour t erred by f inding th ere wa s no unitar y r elationsh ip and tha t, in any event, Me ad faile d its burden of proving that L exis/Nexis was not an operational asset. Because we ag ree with the latter contention, we do not address the Department' s claim of error as to the "lack of unitary busi ness" f

indi ng. Here, among its findings of contested fa cts, the circuit court found that Mead's investment in Lexis/Nexis "did serve an operational purpose, in that L exis/Nexis represented a significant business segment of Mead." The cour t recognized that although, according to testimony of two of Mead' s witnesse s, there was no fu

nctional integr ation of the compan

ies, the c ourt also

found it was "not clear that there was no ope rational purpose." For that conclusion, the court re lied upon the fact that Mead considered L exis/Nexis in its strategic planning, particularly in the allocation of its resources. It conc luded that the "operational purpose allowed Mead to limit the gr owth of Lexis/Nexis if only to limit its ability to e xpand or to contract through its control of capital investment." In its challenge to that finding , Mead relies almost exclusively upon Hercules, Inc. and ASAR CO Inc. v . Idaho S tate T ax Co mm'n , 458 U.S. 307, 73 L. Ed. 2d 787, 102 S. Ct. 3103 (1982), which is cited therein. In Hercules, Inc. , the court reversed a decision that all capital gains f rom a sec ond corp oration owned by the plain tiff cor poration constitute d apporti onable business income because the court determined there was no operational purpose in the plaintiff corporation's investment in the second corporation. Hercules, Inc. , 324 Ill. App. 3d at 343-44. However, the facts of Hercules, Inc. are readily distinguishable from those in the instant case.1-03-1160

-12-

There, gain at

issue re sulted fr

om the pla

intiff He rcules Corporation's sale

of its minor

ity s take in Himont, which had been formed by Hercules in a joint venture with a foreign c orporation. The court rejected the argument that He rcules' investment in Himont served an operational purpose, based in part on Himont's "stand alone" status. Hercules, Inc. , 324 Ill. App. 3d at 338. Hercules never owned a majority

share of Himont and it did not exercise management control over Himont. Here, in contrast to Hercules' minority (38.7%) ownership and lack of manag ement control over its subsidiary cor poration, Mead was 100% owner of L exis/Nexis. Although Mead did not have day-to- day control over Lexis/Nexis, its involvement with Lexis/Nexis was more than mer ely passive. Mead dev eloped Lexis/Nexis by contribu ting ca pital supp ort until it become profitable. Further, Mead c ontinued to approve major capital expenditures by Lexis/Nexis. It also manipulated L exis/Nexis' business organization, treating it as either a division or a corporate subsidiary , depending on what was more benefic ial to Mead. Additionally, Mead reta

ined tax benefits and control over Lexis/Nexis' excess cash. Moreover, in its own 1993 annual report, Mead identified itself as " the developer of the world's leading electronic infor mation retrieval services for law, patents, ac counting, finance, news and business i

nformati on"; likewise, in its 1993 10-K form, Mead described itself as engag ed in ele ctronic

publishing

and inclu ded L exis/Nexis in i

ts discussi on of business seg ments rather than its "investees." Compare Allied-Signal, Inc. , 504 U.S. at 788, 119 L. Ed. 2d at 552, 112 S. Ct. at

2263 (co mpany

's 20.6% ownersh ip of subsi diary

's stock did not est

ablish operati onal rel ationship ); ASARCO Inc. , 458 U.S. a t 321-22, 7 3 L. E d. 2d at 79 8-99, 102S. Ct.1-03-1160

3 We note the Department's citation, as supplemental authority, of the 2004 amendment of the defi nition of b

usiness income in se ction 1501 (a)(1) , to now re ad that " the term ' business income' means all income that may be treated as apportionable business income under the

-13- at 3111-12 (bare majority ownership of stock not enough to show operational relationship in light of lack of ability to control subsidiary ). Mead also relies heavily

in its challenge to the court's finding of ope rational purpose upon its as sertion that the co urt improp erly

consider ed the an nual rep ort and th e 10-K f orm in making that finding. However, Mead pr esents no relevant legal authority to support such assertion. Addition

ally , for the

same poin

t, Mead r elies upon the testi

mony of its exper

ts, particularly tha

t of Dr. Ferdinand Schoettle, an economist, and Professor Richa rd Pomp, a tax law expert. However, experts may not testify with respect to leg al conclusions or give testimony amounting to statutory interpr etations. LI

D Associates v. Dolan , 324 Ill. App. 3d 1047, 1058, 756 N.E.2 d 866 (200 1); Coyne v. Robert H. Ander son & Associates, Inc. , 215 Ill. App. 3d 104, 112, 574 N.E.2d 863 (1991). Therefore, Mead ha s not established that the court's finding of an operational purpose was against the manife st weight of the evidence (see Zebra Technologies Corp. , 344 Ill. App. 3d at 480), nor has it established as clea rly errone ous the conclusion that the gain was nonbusiness income (see Texaco-Cities , 182 Ill. 2d at 268). Next, Mead contends the gain was nonbusiness income under Blessing/White, Inc. v. Zehnder , 329 Ill. App. 3d 714, 768 N.E.2d 332 (2002), beca use it resulted from the liquidation of an entire line of business. The Department responds that Mead did not prove that the gain was not business income. 3 We agree.1-03-1160

Constitution of the United States." 35 IL CS 5/1501(a)(1) (West 2004). The Department contends that the amendment eliminated the languag e in section 1501(a)(1) that was relied upon in Blessing/White, Inc. to recognize the business liquidation exception to the functional test for business income. -14- As previously set forth, the Act defines business income as "income arising f rom transactions and activity in the r egular course of the taxpay er's trade or business," which include s "income from tangible and intang ible property if the a cquisition, management, and disposition of the prope rty constitute

integr al parts o f the taxpa

ye r's re gular t

rade or business. " 35 I

LCS 5/1501(a)(1) (West 2002). Two tests, corresponding to the two cla uses in section 1501(a) (1), are applied t o determine i f income from the dispos ition of a cap ital asset is "busines s income." See Texaco-Cities Service Pipeline Co. , 182 Ill. 2d at 268. Under the first, the " transactional test," if the income is " 'attributable to a ty pe of business transaction in which [the] taxpayer regularly engages,' " it is business income. Texaco-Cities Service Pipeline Co. , 182 Ill. 2d at 269, q uoti ng National Realty & Investment Co. v. Department of Revenue , 144 Ill. App. 3d 541, 554, 494 N.E.2d 924 (1986). Under the second test, the "func tional test," all gain from the disposition of a capital asset is considered business income if the asset disposed of wa s " 'used by the taxpayer in its re gular trade or bu siness ope rations.' " Texaco-Cities Service Pipeline Co. , 182 Ill. 2d a t 269 , quot ing National Realty & Investment Co. , 144 Ill. App. 3d at 554. In the instant case, while Mea d asserts that the gain did not satisfy either the transactional or the functional test, the conclusion reached as to the for mer test is undisputed. Therefore, we1-03-1160

4 The par ties file d an ag

reed mot ion, which was gr

anted, to cite as su pplement al author ity the decision, rendered after the brie fs in this case were filed, in American States Insuranc e Co. v. Hamer , 352 Ill. App. 3d 521, 816 N.E.2d 659 (2004). I n that case, the gain from the sale of a foreign corporation was proper ly treated a s a deemed sale of assets, or nonbusiness income, rather than apportionable business income. American States Insuranc e Co. v. Hamer , 352 I ll. App. 3d at 532. -15- do not con sider the

transactional tes t, but only the func tional tes t. Mead c laims that the gai n qualifie s as nonbu siness inc ome under a "modif ied" form of the f

unctiona l test set f orth in Blessing/White Inc. , 329 Ill. App. 3d 714. There, the corp orate ta

xpayer sold su

bstantial ly a

ll its assets, ceas ed doing

business i

n Illinois, and distributed the proceeds to its individual shareholders. The c ourt held that the functional test is satisfied in such cases only where the property

and the liquidation of assets, i.e. , the disposition, are essential to the taxpayer' s regular trade or opera tions. Blessing/White, Inc. , 329 I ll. App. 3d

at 726. F urther, the cour t found sig

nifican t that the proceed s were " not used to suppo rt any ongo ing bu sines s conc erns b ut, i nstea d, di sburs ed in t heir en tiret y to the co mpany's shareholders ." Blessing/White, Inc. , 329 Ill. App. 3d at 728. 4 Here, in contrast, there was no such disbursement to share holders. Rather, Mead remained in business and reinvested the gain in its ongoing business. Mead paid federal taxes on the gai n, then use d about one-third o f the pro ceeds to buy back stoc k and abo ut two-thi rds to reduce its debt level. While Mead argues that such a ctions increased the value of its shares, and thus benefitted its shareholders, we find such contention unpersuasive in this context. Mead1-03-1160

-16-

reduced its debt levels and the company 's long-term debt to capital ratio from 46% to 30.5%, a nd, using the Lexis/Nexis sale gain, increa sed its working capital to $807 million compared to $380 million the previous year. F urther, unlike the Department's treatment of the taxpayer as two separate corporations under section 338(h)( 10) of the Internal Reve nue Code in American States Insurance Co. , 352 Ill. App. 3d at 531-32, the Department he re claimed that Mead and Lex is /N ex is we re un it ar y. Mead als o relies u

pon case s from for

eign jur isdictions for its contention that the bus iness liquidation exception should apply here. See, e.g. , Lenox, Inc . v. Tolson , 353 N.C. 659, 548 S.E.2d 513 (2001); Laur

el Pipe Line Co. v. Commonweal th , 537 Pa. 205, 642 A.2d 472 (1994); May Depa

rtment Stores Co. v. Indiana Department of State Re venue , 749 N.E.2d 651 (2001). For its part, the Department, recog nizing its failure to raise such argument before the court below normally would re sult in wai

ver of th e issue, n

onethele ss conten

ds that Blessing/White, Inc. is contrary to Illinois law and provides inconsistent precedent with the " business liquidation exception " to the f

unctiona l test for business i

ncome. O n that bas is, it asks t his court to addre ss that doctrine. However, having conc luded that the Lexis/Nexis sale does not fall within the business liquidation exception, set forth in Blessing/White, Inc. , to the functional test for business i ncome, w e need not conside r foreig n authori ties or ad dress the validity of the bus iness liquidation exception. Rather, because Mead reinvested the sale proc eeds in its ongoing business, the cour

t proper ly c oncluded

that the g ain satisf

ied the f unctiona l test and was prope

rly identified as business income. Finally , Mead contends tha

t the inclu sion of the

Lexis/N exis sale g ain in its I llinois1-03-1160

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appor tion able b usin ess in come i s unco nsti tuti onal b ecause it is disp ropor tion ate to Mead's activities in Illinois. The Department responds that Mead ne ver sought alternative apportionment (see 35 IL CS 5/304(f) (West 2002) (party se eking alternative apportionment must petition Director for it)) and that Mead has not proved by the clear and cogent evidenc e required that the incom e attr ibut able t o Illin ois i s " 'out of all appro priat e prop ortio ns to the bu sines s tran sacted ' " in Ill inois ( Container Corp. of America , 463 U.S. at 170, 77 L. Ed. 2d at 556, 103 S. Ct. at 2942, quot ing Hans Ree s' Sons, I nc. v. Nor th Carolina ex rel. M axwell , 283 U.S. 123, 135, 75 L. Ed. 879, 908, 5 1 S. Ct. 385, 3 89 (1931) ). We ag ree and note the D epartme

nt's poin t that, in the case upon which Mead relies almost exclusively, Hans Ree s' Sons, I nc. v. Nor th Carolina ex rel. Maxwell , 283 U.S. 123, 75 L. Ed. 879, 51 S. Ct. 385 (1931), a challenge to the three-factor formula ( like the o ne used b y th e Depar tment) wa s rejec ted by

the Unite d States Sup

reme Cour

t, which held that such formula does not distort income attributable to the State. Container Corp. of America , 463 U.S. at 182-84, 77 L. Ed. 2d at 564-65, 103 S. Ct. at 2949-50 (no unconstit utional dis tortion ev en wher e combine d apporti onment converted net losse s into substantial profits). See also Penzoil Co. v. Department of Revenue , 332 Or. 542, 550 n.4, 33 P.3d 314, 3 18-19 n.4 (2 001) ( findi ng " Hans Rees ' is of l imit ed val ue" in t he sta tes us ing a multifactor apportionment). Moreover, as the Department maintains, Mead did not establish that either it or Lexis/Nexis did not do substantial business in Illinois. As the Department notes, Mead's 1994 tax return indicates that the contrary is true: Mead reported I llinois sales of more than $338 million, of which over $46 million were attributable to Lexis/Nexis. Mead also relies upon a1-03-1160

-18-

conclusion by its accounting expert, Kennion Yano, of distortion, but that testimony was considered by

the circuit court, along with the auditor's cr iticism of Yano's evidence. The court ultimately struck Yano' s conclusion. Mead has not proven clearly and cogently

that the apportionment of the Lexis/Nexis gain was grossly disproportionate to its Illinois income or activ itie s. For the rea sons state d abov e, Mead has no t esta blis hed as clearl y erroneou s the c ourt's conclusion that the gain from the sale of L exis/Nexis was apportionable business income. Mead als o contend s that the g ross rec eipts from the sale of financial instr

uments sho

uld be included in the calculation of its sales factor on its 1994 I llinois tax return. This issue of whether the Department properly excluded from the sales factor denominator the $4.8 billion that Mead reported in gross rece ipts of financial instruments was decided on the parties' cross-motions for summary judgment. Accordingly, because the issue was resolve d on motions

for summa

ry judgmen t, which is

grante d where

the plea dings, d eposition s, admissions, and affidavits, if any, show that there is no genuine issue of material fac t and the moving pa

rty is entitle d to judgment as a matter of law, rev iew is de novo . 735 IL CS 5/2-1005(c) (West 2002 ); Arangold Corp. v. Zehnder , 204 Ill. 2d 142, 146, 787 N.E.2d 786 (2003). As previously noted, section 304 of the Act, which governs business income of persons other than residents, provides in subsection (a) an apportionment formula f or corporations conducting business in Illinois. 35 I LCS 5/304(a) (West 2002). As set forth in section 304(a), one of the factors used in calculating this formula is the " sales factor," which is "a fr action, the numerator of which is the total of sales of the person in this State during the taxable y ear, and the denominator of which is the total sales of the person every where during the taxable y ear." 351-03-1160

-19-

IL CS 5/304(a)(3)(A) (West 2002). Section 304 also explicitly allows for alternative allocation upon petition of either the taxpayer or the Director of the Department if the apportionment provisio ns "do not fai rly represent the ex tent of [t he taxpayer's] bus iness activ ity in this St ate." 35 IL CS 5/304(f) (West 2002). Mead re lies on the

definition in section 1501(a )(21) of the Act w

hich state s that " ' sales' means all gross receipts of the taxpay er not allocated under Sections 301, 302, and 303" (35 IL CS 5/1501(a)(21) (West 2002)) for its claim that the gross rece ipts from the sale of financial instruments should be included in the calculation of its sales factor on its 1994 I llinois tax return.

Yet, section 1501 ( "Defin itions")provides

gener ally that the st

ated def inition app lies "in t

his Act, where not otherwise distinctly expressed or manifestly incompa tible with the intent thereof" (35 IL CS 5/1501(a) (West 2002)), but, as noted, section 304, which addresses the "sale s factor," explicitly allows for alternative alloca tion upon petition of either the taxpayer or the Director (35 IL CS 5/304(f) (West 2002)). Although "sales," then, may mean all gross receipts of the taxpay er that otherwise qualify a s business income (see 35 ILCS 5/1501(a)(21) (West 2002)), under the standard apportionment formula, section 304 explicitly provide s for modification of the apportionment provisions (35 IL CS 5/304(f) (West 2002)); therefore, we reject Mea d's argument that the plain language of the statute re quires the inclusion of the disputed gross receipts in the calculation of the sales factor. Rather, in accordance with the authority granted by

section 304(f), section 100.3380 of1-03-1160

5 The Department notes that, in 2002, section 100.3380 was amended to state more explicitly that it was enacted in fulfillment of section 304(f) of the Act. See 26 Ill. Reg . 15304, 15314 (eff. October 9, 2002), codified, at 86 I ll. Adm. Code §100.3380.

6 We note the

additiona l foreig n authori ty c ited by

the Depa rtment, in cluding its supplemental authority, Toys "R" Us, Inc. v. Franc hise Tax Board , 138 Cal. App. 4th 339, 41 -20- the Department's regulations wa s enacted. See 86 Ill. Adm. Code §100.3380 (1996)

. 5 Section 100.3380(b)(6) provides special rules for computing the sales factor; one of those rules gover ns the sale of business intangibles and provides that "[i]n the case of sales of busine ss intangibles *** gro ss rece ipts shall b e disreg arded a nd only the net g ain (loss)

theref rom shall b e include d in the sales factor." 86 I ll. Adm. Code §100.3380(b)(6) (1996). Mead asserts that the Department cannot "c ircumvent" the meaning of the statute by adopting a regu lation. However, the Depa rtment ha s proper

authority to make r

easonab le regulations, which have the force and effect of law. Exhibits, Inc. v. Sweet , 303 Ill. App. 3d 423, 427, 709 N.E.2d 236 (1998). The regulation, which is construed unde r the same standards governing the construction of statutes, is presumed to be va lid, and the burden of establishing the regulation is unconstitutional is charged to the party challenging its validity

. Exhibits, Inc. , 303 Ill. App. 3d at 427. In its challenge to the va

lidity of the reg

ulation at issue, Mead relies primarily upon the testimony of its experts and a ge neral principle concerning administrative r ules. See Canteen Corp. v. Department of Revenue , 123 Ill. 2d 95, 108, 525 N.E.2d 73 (1988) (administrative rules can neither limit nor extend the scope of a statute). 6 While the Department questions the1-03-1160

Cal. Rptr. 3d 285 (2006), Microsoft Corp. v. Franchise Tax Board , 39 Cal. 4th 750, 139 P.3d 1169, 47 Cal. Rptr. 3d 216 (2006), and General Motors Corp. v. Franchise Tax Board , 39 Cal. 4th 773, 13 9 P.3d 1183, 47 Cal. Rptr . 3d 233 (2 006), in su pport of t he exclusi on of the g

ross receipts from the sale of financial instruments from the taxpay er's sales factor denominator. -21- competency

of the testimony of Mead' s experts (see, e.g. , LI D Associates , 324 Ill. App. 3d at 1058), we do not find Mead's argume nt persuasive and, in any

event, believe that section 304(f) of the Act and section 100.3380 were corre ctly applied here

. Again, section 304(f) explicitly provides for modification of the apportionment provision s to avoid u

nfair re present ation of the extent of

the taxpay

er's bu siness activity

in Illinois. 35 ILCS 5/304(f) (West 2002). The inclusion of the gross receipts from the sale of financi al instruments in Me ad's sa les fac tor denom

inator wo uld not have resulte d in a fai r repres entat ion o f its busi ness a ctivi ty; the gro ss rece ipts add ap prox imat ely $4.8 b illi on to Mead's sales factor denominator when it actually earned only

about $1.9 million on those investments. Accordingly , we believe summary judgment was properly

granted in favor of the Depa rtment on this issue. Therefore, we affirm the judg ment of the circuit court as set forth in its orders of December 2, 2002, and March 18 and 25, 2003. Affirmed. McNULTY and O' MALLEY, JJ., concur.