FIRST DIVISION

										August 11October 27, 2003

Nos. 1-01-2861 & 1-02-0386 (Consolidated)

ZEBRA TECHNOLOGIES CORPORATION,    		       

	Plaintiff-Appellant and Cross-

Appellee,

	v.				

JUDY BAAR TOPINKA, as Treasurer of the

State of Illinois, and THE DEPARTMENT OF

REVENUE,	

	Defendants-Appellees and Cross-

Appellants.

)	Appeal from the 

)	Circuit Court

)	of Cook County.

)

)

)	

)

)

)

)

)	Honorable

)	Joanne L. Lanigan,

)	Judge Presiding.

)

)

)

Modified Upon Denial of Rehearing

	PRESIDING JUSTICE O'MALLEY delivered the opinion of the court:

	The Illinois Department of Revenue (the Department) conducted an audit

of Zebra Technologies' (taxpayer) corporate income tax returns for the years

ended 1993, 1994 and 1995 (audit period).  The Department included in

taxpayer's unitary group subsidiaries that taxpayer previously excluded and

treated certain income as business income that had been allocated to another

state as nonbusiness income.  Taxpayer paid all proposed adjustments with

interest under protest.  The Department did not issue an official notice of

deficiency.  Taxpayer then filed an action in the circuit court of Cook

County.  The circuit court found in favor of the Department.  Taxpayer filed

this timely appeal and we now affirm.     

 BACKGROUND

	Taxpayer is a corporation engaged in the business of manufacturing two-

dimensional bar coding equipment and related supplies that it sells throughout the world.  Taxpayer is incorporated in Delaware with its corporate headquarters located in Vernon Hills, Illinois, and has several wholly owned

subsidiaries located both within and outside the United States.  Taxpayer,

through its employees, developed patents, trademarks and other intellectual

property, both before and after the audit period, used in the manufacture and

sale of its products.  Taxpayer deducted from its taxable income the expenses

it incurred to develop and maintain this intellectual property. 

	Charles Whitchurch was taxpayer's chief financial officer and a director

in each of the subsidiaries involved in this matter.  Additionally, at all

times during the audit period, a majority of the directors of each subsidiary

referenced in this appeal were also officers or directors of taxpayer.  Each

subsidiary is described in greater detail below.  

Bermuda Subsidiaries

	In 1994, taxpayer incorporated two wholly owned subsidiaries in

Delaware, Zebra Domestic Intangibles (ZDI) and Zebra International Intangibles

(ZII).  Taxpayer transferred all of its intellectual property to ZDI and ZII

and then each corporation licensed the intellectual property back to taxpayer

and taxpayer's affiliated companies.  ZDI licensed intellectual property used

in the United States, while ZII licensed intellectual property used outside

the United States.  

	ZDI and ZII charged a royalty of 9.5% of the gross sales of the products

using the intellectual property to taxpayer and its affiliated corporations. 

After receiving the royalty payment, ZDI and ZII would pay its respective

expenses and would declare a dividend of the remaining amount to taxpayer. 

Transfers of these funds occurred at a bank located in Illinois where

taxpayer, ZDI and ZII had accounts.  Taxpayer would transfer the royalty

payments from its account at the bank located in Illinois to ZDI and ZII's

account at the same bank.  ZDI and ZII would simply do the reverse of the

aforementioned transaction, minus expenses, to pay out the dividend to taxpayer.  Taxpayer contends that the purpose of incorporating ZDI and ZII was

to own, protect and license trademarks, patents and other intellectual

property once belonging to taxpayer.  

	In 1995, ZDI and ZII moved its corporate headquarters to Hamilton,

Bermuda, where each company rented office space and each paid $1,000 for a

computer.  Each company employed Steven Hantelman, a former certified public

accountant and investment banker, to manage business affairs for the

companies.  He had no experience in managing intellectual property, trademark

rights or patents.  He testified that his services consisted mostly of signing

registration applications and renewal papers sent to him by the law firm that

handled taxpayer's intellectual property matters.  Hantelman also testified

that he received quality control reports from taxpayer's department heads

which he read, signed and filed.  Hantelman was paid $600 per month by each

company for the performance of various duties related to the business of ZDI

and ZII pursuant to an employment agreement.    

Delaware Subsidiary

	In 1993, taxpayer incorporated ZIH, Inc., a wholly owned subsidiary of

taxpayer, in Delaware with its corporate headquarters located in Wilmington,

Delaware.  Taxpayer contributed two large portfolios of cash and marketable

securities to ZIH in exchange for all of ZIH's capital stock in 1993.  ZIH

placed the portfolios of cash and marketable securities with Smith Barney and

Capital Insight, professional investment corporations, to invest and reinvest

the earnings in accordance with taxpayer's investment policies.  Whitchurch

oversaw the managers' compliance with taxpayer's investment policy and

recommended that the portfolio managed by Capital Insight be liquidated,

thereafter ZIH implemented this recommendation.  A local company provided site

management services for ZIH in Wilmington, Delaware.

	During taxpayer's audit period, ZIH owned two subsidiaries.  In

September 1993, Zebra Technologies Preston (Preston) was created as a wholly owned subsidiary of ZIH for the purpose of acquiring all the assets of an

unrelated company known as Brooks Labels & Consulting (Brooks).  In order to

accomplish the acquisition of Brooks Labels, ZIH contributed $828,0251 in the form of a promissory note to Preston and Preston immediately used the cash to

purchase the assets of Brooks Labels.  In April 1994, ZIH made a capital

contribution to Preston of the note securing the loan to Preston.  Also in

April 1994, ZIH acquired a second subsidiary, Zebra Technologies Europe, Ltd.

(Europe), that had been organized as a wholly owned subsidiary of taxpayer,

but was later organized as a wholly owned subsidiary of ZIH through an

exchange of stocks plus a payment of $12,661 by ZIH to taxpayer.  Preston then

became a wholly owned subsidiary of Europe.  Taxpayer's Illinois income tax

returns for the audit period listed ZIH as a part of its unitary business

group, but classified the income as nonbusiness income allocable to the state

of commercial domicile. 

The Audit and Trial

	The Department conducted an audit of taxpayer's Illinois corporate

income tax returns for the years ending December 31, 1993, 1994 and 1995.  In

its returns for tax years 1994 and 1995, taxpayer excluded ZDI and ZII from

its unitary business group.  For the tax years 1993, 1994 and 1995, taxpayer

included ZIH in its unitary business group, but allocated all of its income to

Delaware, its state of commercial domicile, as nonbusiness income.  

	Pursuant to its audit, the Department included ZDI and ZII in the

unitary business group for the 1993 and 1994 tax years and included ZIH's

income as business income, subject to apportionment in Illinois.  The

Department did not impose any penalties and taxpayer paid, under protest, the

amount of all proposed adjustments in full with interest.  Taxpayer then filed

this action in the circuit court of Cook County seeking a determination of its actual income tax liability and a refund for any overpayments.

	After a three-day bench trial, the circuit court entered an order on

July 23, 2001, finding that all subsidiaries in question were properly

included in taxpayer's unitary business group for purposes of section 1501 of

Illinois Income Tax Act (the Act) (35 ILCS 5/1501 (West 2000)).  The trial

court also found that the income of ZIH was taxable in Illinois to the extent

that the income was used to fund corporate acquisitions, but not taxable as to

any amount not used in business operations.  

	 The trial court's first order determined neither the amount of tax owed

to the Department nor the refund, if applicable, to taxpayer.  At taxpayer's

request, the circuit court issued a second order on August 8, 2002, making a

Supreme Court Rule 304(a) (155 Ill. 2d R. 304(a)) finding relative to most of

the July 23, 2001 order.  The parties then entered into a stipulation as to

the amount that would be refunded to taxpayer from the protest fund if the

circuit court's ruling in the July 23, 2001, order were applied to the facts

of this action.  Pursuant to this stipulation, the trial court entered a

judgment specifying the amount to be refunded to taxpayer in accordance with

the rulings in its July 23, 2001, order.  Taxpayer filed a new notice of

appeal and the Department cross-appealed claiming that all income earned by

ZIH was subject to apportionment as business income, not just the amount

actually used in the acquisition of new corporations.   

ANALYSIS

I. Standards of Review

	This court reviews pure questions of law under a de novo standard of review, without deference to the circuit court concerning the content of any

rule of law relevant to this proceeding.  Zeitz v. Village of Glenview, 304 Ill. App. 3d 586, 592, 710 N.E.2d 849 (1999).  The circuit court’s finding of

fact, however, is entitled to deference by this court and may be reversed only

if it is contrary to the manifest weight of the evidence.  Zeitz, 304 Ill. App. 3d at 592.  Mixed questions of fact and law, which involve the

application of law to a particular set of facts, are subject to review under

the clearly erroneous standard, affording the circuit court less deference

than for questions of fact.  Zeitz, 304 Ill. App. 3d at 592.  Under the clearly erroneous standard of review, a finding by the trial court may be

reversed only if, after careful examination of the record in light of the

applicable rule of law, the reviewing court is left with the "definite and

firm conviction" that the finding is in error.  AFM Messenger Service, Inc. v. Department of Employment Security, 198 Ill. 2d 380, 395, 763 N.E.2d 272 (2001).

II. Jurisdiction

	The Department argues in its brief that this court lacks jurisdiction over appeal number 1-01-2861.  Without belaboring this point, we agree with

the Department because the trial court's original order was not a final

judgment under Supreme Court Rule 304 (155 Ill. 2d R. 304).  Appeal number 1-

01-2861 is therefore dismissed.  The Department, however, conceded at oral

argument that the trial court's subsequent order incorporating the parties'

stipulations was a final judgment as contemplated by Rule 304 (155 Ill. 2d R.

304) and appeal number 1-02-0386 is otherwise identical to appeal number 1-01-

2861.  This court properly has jurisdiction over appeal 1-02-0386 and we will

address the claims therein.

III. 	The Bermuda Subsidiaries

	Taxpayer contends that the trial court erred as a matter of law in

failing to exclude ZDI and ZII from taxpayer's unitary group.  It claims that

the trial court found that all property owned and leased by ZDI and ZII was

located outside the United States and that all compensation paid by ZDI and

ZII was paid for services rendered in Bermuda.  Based on these findings,

taxpayer argues that the trial court was required to exclude the two

subsidiaries from the unitary group.  Although taxpayer characterizes this issue as a flawed legal conclusion made by the trial court to be reviewed de novo, we view this contention as a factual decision that will be disturbed only if against the manifest weight of the evidence.  Zeitz, 304 Ill. App. 3d at 592.

	Section 1501 (a)(27) of the Act provides, in pertinent part:  "The group

will not include those members whose business activity outside the United

States is 80% or more of any such member's total business activity ***."  35

ILCS 5/1501(a)(27) (West 2000).  After reviewing the record, we are of the

view that taxpayer misstates the finding of the trial court.  In its order,

the trial court never indicated that all payroll was located outside of the

United States.  Although the court found that Hantelman was an employee and

properly included in ZDI and ZII's payroll in Bermuda and not considered to be

within the United States for purposes of section 1501(a)(27) of the Act,

commonly referred to as the 80/20 rule, it also determined that other

activities related to the functions of ZDI and ZII were conducted within the

United States.  

	For purposes of clarity, we find it appropriate to include a significant

portion of the trial court's findings in its written order to show that it did

not find, as taxpayer alleges, that all payroll was found to be in Bermuda. 

The court made the following findings in its order:

	   "For Zebra to satisfy the 80/20 rule, it must prove that 80% or more

of its property and payroll factors are outside the United States.  This

was established by a lease executed in 1995 and the purchase of a

computer in 1995 which was paid by Domestic [ZDI] and International

[ZII].  The evidence established that Domestic and International had no

payroll in 1994.  The employment agreement did not commence until

January 1, 1995.  Mr. Hantelman testified that he executed an employment

contract with each company and was paid a salary of $600.00 a month by

each from which income and payroll taxes were withheld.  He testified that he dealt with outside patent counsel to register and protect the

intellectual property owed by the two corporations and he performed

quality control in addition to his other duties with respect to

operating the companies.  He testified both companies had separate bank

accounts in Bermuda from which he paid the companies' expenses and both

companies had an account at American National Bank in Chicago.  He

testified that he prepared invoices for royalty fees and collected those

fees.  He testified he executed wire transfers from the American

National Bank account to pay dividends declared by the companies which

then were deposited into an account of Zebra at American National Bank. 

Mr. Hantelman testified he had no prior experience dealing with patents

or trademarks.  When the quality control assurance reports were sent to

the companies he read them and filed them.  He testified he was under

control of the Board of Directors of both companies as to performance of

his duties.  He was told how to set up the accounting system for the

companies.  He sent written reports to Zebra regularly.  Even though Mr.

Hantelman worked for other companies, based on his testimony and the

testimony of Mr. Johnson the manifest weight of the evidence shows that

Mr. Hantelman was a part-time employee for Domestic and International

and the performance of his duties was under the control and supervision

of the Bermuda companies.

	   Despite these findings, the testimony and the documents introduced into evidence clearly indicate Domestic and International had other

individuals in the U.S. performing activities for these companies.  Mr.

Hantelman testified that one of his duties was to protect the

intellectual property and he performed quality control.  Quality control

by the licensor (the Bermuda Companies) was required by the License

Agreements introduced into evidence by the department as its exhibits 18

and 19.  The evidence, however, showed that while the Bermuda Companies issued the licenses to use the patents, Mr. Hantelman never performed

any quality control.  Mr. Hantelman testified that it was Zebra that had

a quality control committee comprised of department heads and managers

in various areas and they would prepare a set of minutes from each of

their meetings where they went through strict guidelines established by

Zebra.  He would receive the quality control committee minutes, review

them and then file them.  Mr. Whitchurch also testified that one of the

business activities of the two Bermuda companies was to insure that

trademarks appeared on quality products and that the value of the

trademarks was not decreased by appearing on products of inferior

quality.  As noted previously, Mr. Hantelman testified he had no

previous business experience working with patents, trademarks or

intellectual property.  His duties as an employee were ministerial.  The

highly important function of protecting the patents was retained by

Zebra, the Taxpayer, at no cost to the Bermuda companies.  There was no

evidence of a contractual relationship between Zebra and the Bermuda

companies for the purchase of these highly technical services.  This

situation requires a look at substance over form.  These monthly

meetings of the quality control committee evince a considerable amount

of business activity taking place in the U.S. for Domestic and

International.  The Department's witness stated there was no statute

that allowed the Department to impute a payroll figure for these

services.  However, Zebra knew the amount of time spent by the committee

on quality control issues and was capable of allocating this expense to

the Bermuda companies because it was this committee which was protecting

the license for these companies.  

	   Based on the above this Court finds Zebra did not meet its burden of

proof showing that 80% or more of its business activities took place

outside the United States."  (Emphasis added.)

	The issue properly before the court is whether taxpayer has satisfied

its burden to show that it was entitled to exclude ZDI and ZII from its

unitary business group.  Taxpayer argues that section 1501(a)(27) of the Act prohibits the inclusion of subsidiaries that conduct at least 80% of their

business activities outside the United States.  Taxpayer in essence contends

that it produced evidence of its payroll and property showing that it complied

with the "statutory mandate" and therefore the court should have excluded ZDI

and ZII without further analysis or inquiry.  We disagree.  

	The 80/20 rule, in our view, is an exception to the rule annunciated in

section 304(e) of the Act, which states:

	   "Where 2 or more persons are engaged in a unitary business as described in subsection (a)(27) of Section 1501, a part of which is

conducted in this State by one or more members of the group, the

business income attributable to this State by any such member or members

shall be apportioned by means of the combined apportionment method."  35 ILCS 5/304(e) (West 2000).

	We are mindful that taxation is the rule and tax exemption is the

exception.  Chicago Bar Ass'n v. Department of Revenue, 163 Ill. 2d 290, 301, 644 N.E.2d 1166 (1994).  Here, taxpayer is claiming an exemption from tax on income that would otherwise be assessed but for the 80/20 rule.  Thus,

taxpayer has the burden of proving clearly that it comes within the statutory

exemption.  United Air Lines. Inc. v. Johnson, 84 Ill. 2d 446, 455-56, 419 N.E.2d 899 (1981).  Such exemptions are to be strictly construed, and doubts concerning the applicability of the exemptions will be resolved in favor of

taxation.  United Air Lines, 84 Ill. 2d at 455.  

	We find that the taxpayer failed to sustain its burden of proving that

ZDI and ZII should have been excluded from the unitary group.  Although the

trial court agreed that all property owned by ZDI and ZII was located in

Bermuda, it found that a considerable amount of business activity relating to development, protection and quality control of the intellectual property took

place within the United States.  Because taxpayer knew the extent to which

this activity was conducted in the United States, it could have calculated the

percentage of the activities conducted within and without the United States

such that it could show compliance with the exemption requirements in section

1501(a)(27) of the Act.  35 ILCS 5/1501(a)(27) (West 2000).  Although taxpayer

was the only one able to produce the evidence necessary to show that it was

entitled to the exclusion under the 80/20 rule, it chose to stand on the evidence it produced about the property and Hantelman's salary and nothing

more.  The trial court was not required to accept the evidence produced by

taxpayer as dispositive, especially when its own witnesses testified on direct

examination that elements of development and protection of intellectual

property were conducted by taxpayer's employees within the United States.  

	We also find it important to note that the Department devoted a large

part of its argument to the idea that ZDI and ZII lacked economic substance as

an additional basis for finding that ZDI and ZII should be included in

taxpayer's unitary group.  Relative to this issue the court made the following

statements in its order:

	   "The Department argued that the Court should look at substance rather

than a form devised by Zebra.  The Department argued Zebra should have a

business purpose for engaging in a transaction other that tax avoidance. 

Further, the Department contended Mr. Hantelman was an independent

contractor because he retained the right to control the manner of doing

the work as shown by the evidence.

	   * * *

	   Mr. Whitchurch testified the business purpose for creating Domestic

and International was: 1) to improve the management and control of

Zebra's intellectual property; 2) to provide an additional layer of

corporate protection for the intellectual property; 3) to take advantage of certain tax benefits; and 4) to permit the financial statements to

reflect the true value of the intellectual property by assigning a

charge through the royalty mechanism to the products that used this

property.  Based on this evidence, which was not refuted, the Court

finds there was a genuine economic substance to forming Domestic and

International even though the formation of these companies in Bermuda

was also for the purpose of avoiding taxes."

We decline to address the Department's argument because the disposition of

this issue, whether it be in favor of the Department or taxpayer, would not

effect the outcome of our decision.  Here, taxpayer failed to sustain its

burden on the threshold issue of qualifying to exclude ZDI and ZII from its

unitary business group under section 1501(a)(27) of the Act.  35 ILCS

5/1501(a)(27) (West 2000). 

IV. ZIH Commerce Clause and Due Process Challenge

	Taxpayer claims that the trial court erred as a matter of fact and law

by subjecting any funds of ZIH to taxation in Illinois.  First, taxpayer

claims that none of the funds held by ZIH and used in the reorganization were

used for operational purposes and, therefore, any imposition of tax by

Illinois on this income would violate the commerce clause of the United States

Constitution.  

	The due process and commerce clauses of the United States Constitution

require that a definite link or minimum connection exist between a state and

the transaction it seeks to tax.  Quill Corp. v. North Dakota, 504 U.S. 298, 306, 119 L. Ed. 2d 91, 102, 112 S. Ct. 1904, 1909-10 (1992).  As a result, a

state may not tax value outside its borders.  Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 119 L. Ed. 2d 533, 112 S. Ct. 2251 (1992).  A state may, however, impose a tax on the multistate income of a

nondomiciliary corporation if a minimal connection exists between the

corporation's activities and the taxing state and a rational relationship exists between the income sought to be taxed by the state and the intrastate

value of the corporate business.  Allied-Signal, 504 U.S. at 772, 119 L. Ed. 2d at 542, 112 S. Ct. at 2255.

	When determining whether a state may apportion corporate income of a nondomiciliary corporation, the United States Supreme Court has applied the

"unitary relationship" and "operational function" tests.  Home Interiors & Gifts Inc. v. Department of Revenue, 318 Ill. App. 3d 205, 210-11, 741 N.E.2d 998 (2000).  Under the unitary relationship test, the payee and the payor of

the dividend or other income have a unitary business relationship.  Home Interiors, 318 Ill. App. 3d at 211.  More specifically, although a business may have subsidiaries, divisions, or common ownership of other businesses that

operate in different jurisdictions, a single state may tax all the income

earned and apportion it because the businesses have common managerial or

operational resources that produce economies of scale and a substantial

sharing of values.  Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 179, 77 L. Ed. 2d 545, 562, 103 S. Ct. 2933, 2947 (1983).  It is

well established that "'[t]he linchpin of apportionability in the field of

state income taxation is the unitary-business principle.'"  (Emphasis

omitted.)  ASARCO Inc. v. Idaho State Tax Comm'n, 458 U.S. 304, 317, 73 L. Ed. 2d 787, 795, 102 S. Ct. 3103, 3109 (1982), quoting Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 439, 63 L. Ed. 2d 510, 522, 100 S. Ct. 1223, 1232 (1980).

	Under the operational function test, a state may apportion income even

though no unitary relationship exists between payee and payor.  Allied-Signal, 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.  The state has the

authority to apportion the income because the capital transaction serves an

operational rather than an investment function.  Allied-Signal, 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.  The relevant inquiry in

determining whether an asset serves an investment or operational function "focuses on the objective characteristics of the asset's use and its relation

to the taxpayer and its activities within the taxing State."  Allied-Signal, 504 U.S. at 785, 119 L. Ed. 2d at 550, 112 S. Ct. at 2262.  The United States

Supreme Court has noted that "a State may include within the apportionable

income of a nondomiciliary corporation the interest earned on short-term deposits in a bank located in another State if that income forms part of the

working capital of the corporation's unitary business, notwithstanding the

absence of a unitary relationship between the corporation and the bank."

Allied-Signal, 504 U.S. at 787-88, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.  The Court concluded that the apportionability of interest turns on whether the

interest is part of the working capital of the unitary business.  Allied- Signal, 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.  The existence of a unitary relation between the payor and the payee is one means

of meeting the constitutional requirement.  Allied-Signal, 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.  If a capital transaction serves an operational rather than an investment function, the constitutional requirement

will likewise be met even if no unitary relationship exists between payor and

payee.  Allied-Signal, 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.

	Here, although no unitary relationship existed between the professional

investment companies and ZIH, the trial court found that the funds used to

assist Preston in acquiring Brooks, that came from ZIH, served an operational

function rather than an investment function.  The due process and commerce

clauses were not violated because the minimal connection necessary between

taxpayer and Illinois was satisfied.  The facts and the evidence presented at

trial show that a rational relationship existed between the income attributed

to Illinois and the intrastate value of the corporate business. 

	However, we disagree with the Department as to its claim in its cross-

appeal that all interest income earned by ZIH is taxable in Illinois, not just that which was used to acquire Brooks.  We conclude, as did the court in Home Interiors, that taxpayer's use of the funds, not the mere availability of the funds, is the guiding factor in determining whether the income sought to be

apportioned has an operational or investment function.  Home Interiors, 318 Ill. App. 3d 212-13.  Here, the operational function test only permits the

Department to tax a portion of taxpayer's income from the portfolio investment

accounts, because only part of these funds was used as working capital.  The

remaining funds within these accounts served an investment function and did not form part of the working capital of plaintiff's business.  Accordingly, we

agree with the trial court that, relative to the funds that remained invested,

the requisite minimal connection between ZIH and Illinois does not exist and

that the investment income was not rationally related to the operations of

taxpayer.

V. Business and Nonbusiness Income

	Taxpayer next claims that even if Illinois can constitutionally tax

ZIH's income, the entire amount of interest income at issue is nonbusiness

income and subject to allocation to Delaware, ZIH's state of commercial

domicile.  The Department argued that all of the income earned by ZIH was

business income and was subject to taxation in Illinois on an apportioned

basis.  

	We begin the analysis of this issue with the definition of "business

income."  Section 1501(a)(1) of the Act defines "business income" as follows:

	   "The term 'business income' means income arising from transactions

and activity in the regular course of the taxpayer's trade or business,

net of the deductions allocable thereto, and includes income from

tangible and intangible property if the acquisition, management, and

disposition of the property constitute integral parts of the taxpayer's

regular trade or business operations."  35 ILCS 5/1501(a)(1) (West

2000).  

Income is presumed to be business income unless it is clearly classifiable as

nonbusiness income.  Automatic Data Processing, Inc. v. Department of Revenue, 313 Ill. App. 3d 433, 440, 729 N.E.2d 897 (2000).  Courts have interpreted the

statute as setting out two tests for determining whether income is business

income, namely, the "transactional test" and the "functional test."  National Realty & Investment Co. v. Department of Revenue, 144 Ill. App. 3d 541, 554, 494 N.E.2d 924 (1986).  Income is properly classified as business income if

either test is met.  Borden, Inc. v. Department of Revenue, 295 Ill. App. 3d 1001, 1010, 692 N.E.2d 1335 (1998).  The taxpayer has the burden to show that

a disputed gain is not business income.  National Realty, 144 Ill. App. 3d at 553, 494 N.E.2d at 932 (1986).  

	The transactional test is used to determine whether the income in

question arises from transactions and activities in which the taxpayer

regularly engages.  Borden, 295 Ill. App. 3d at 1010, 692 N.E.2d at 1341.  The functional test, on the other hand, determines whether the income comes from

the acquisition, management and disposition of property used in the taxpayer's

regular trade or business.  National Realty, 144 Ill. App. 3d at 554, 494 N.E.2d at 932. 

	Here, the court did not find that the transactional test was satisfied. 

The court noted that the portfolios were transferred to ZIH from taxpayer and

never reverted back, no inter-company loans were issued and the portfolios

were never used as collateral for other obligations.  The investments did not

arise from transactions or activities in which the taxpayer regularly engaged. 

Automatic Data Processing, 313 Ill. App. 3d at 440.  We agree with the findings of the trial court that the transactional test was not satisfied. 

	The trial court then applied the functional test and determined that the

funds used by ZIH that came from the portfolios to effectuate the acquisition

of Brooks satisfied the requirements under the functional test. 

Notwithstanding taxpayer's claim that no funds were used for an operational purpose, the trial court found that the contribution of capital to Preston was

business income because those funds were eventually used to acquire Brooks. 

Relative to this issue, Whitchurch wrote a memo to taxpayer's board of

directors in 1993 explaining the purpose of forming ZIH.  The memo, which was

admitted into evidence, read in pertinent part:

	   "The purpose of the Subsidiary would be to manage the Investment

Portfolios.  The Subsidiaries' income would consist of dividends and

interest earned on its investments and capital gains or losses from the

sale of its investments.  Since the purpose of the Investment Portfolios

has always been to provide capital for financing potential corporate

acquisitions by the company and no such acquisitions have been made as

of this date, the Investment Portfolios would continue to be earmarked

for such company acquisitions."  

	After reviewing the record, we agree with the trial court's conclusion. 

The evidence in the record indicates that the two investment portfolios were

earmarked for corporate acquisitions both before and after the transfer to

ZIH.  Whitchurch testified at trial that money from the investment funds was

used to complete a corporate reorganization that involved the changing of

ownership of Preston within taxpayer's corporate family.  We find that the

functional test was met when ZIH used the funds for a corporate reorganization

and acquisition in accordance with taxpayer's designated purpose for the use

of the portfolios.  The record reflects that the acquisition, management and

disposition of funds were an integral part of taxpayer's business operation,

and we agree that the income from the investments used to acquire Brooks

served an operational rather than an investment function.  Texaco-Cities Service Pipeline Co. v. McGaw, 182 Ill. 2d 262, 269, 695 N.E.2d 481 (1998).  Accordingly, that income was properly taxable on an apportioned basis in

Illinois.  

VI. ZIH as Part of the Unitary Group

	Taxpayer next contends that ZIH was improperly included in its unitary

group and the tax imposed violated article IX, section 2, of the Illinois

Constitution (uniformity clause), which provides:

	   "In any law classifying the subjects or objects of non-property taxes

or fees, the classes shall be reasonable and the subjects and objects

within each class shall be taxed uniformly.  Exemptions, deductions,

credits, refunds and other allowances shall be reasonable."  Ill. Const.

1970, art. IX, § 2.

Taxpayer argues that even though it filed its corporate income tax returns

with ZIH as part of the unitary group, it should have been excluded from the

group because it was a financial organization under section 1501(a)(8) of the

Act.  At trial, the court determined that ZIH did not qualify as a financial

organization because it was not a regulated investment company and that the

distinction drawn between regulated and nonregulated investment companies did

not violate the uniformity clause of the Illinois Constitution.  

	Section 304(c) of the Income Tax Act requires that "financial

organizations" use a formula different from ordinary three-factor

apportionment.  This formula multiplies the organizations' income by a

fraction, the numerator of which is the business income from within the state and the denominator of which is business income from all sources.  35 ILCS

5/304(c) (West 2000).  The business income from within Illinois consists of:

	   "(A) Fees, commissions or other compensation for financial

services rendered within this State;

	   (B) Gross profits from trading in stocks, bonds or other

securities managed within this State;

	   (C) Dividends, and interest from Illinois customers, which are

received within this State;

	   (D) Interest charged to customers at places of business maintained within this State for carrying debit balances of margin

accounts, without deduction of any costs incurred in carrying such

accounts; and

	   (E) Any other gross income resulting from the operation as a

financial organization within this State."  35 ILCS 5/304(c) (West 2000).

Section 1501(a)(8) of the Act defines "financial organization" as: "any bank,

bank holding company, trust company, savings bank, industrial bank, land bank,

safe deposit company, private banker, savings and loan association, building

and loan association, credit union, currency exchange, cooperative bank, small

loan company, sales finance company, investment company, or any person which is owned by a bank or bank holding company." (Emphasis added.)  35 ILCS

5/1501(a)(8) (West 2000).  Taxpayer claims that ZIH is a financial

organization within the meaning of the Income Tax Act because it is an

investment company.  The Department argues that the Act should be interpreted

to require that a financial organization be a regulated investment company

registered with a governmental agency and conducting its business with the

public, even though no definition is given for the term "investment company." 

		At the outset, we note that this court considered this same issue in

Automatic Data Processing, 313 Ill. App. 3d at 442-46, although it did not consider whether the distinction between regulated and nonregulated investment

companies violated the uniformity clause of the Illinois Constitution.  The

Automatic Data Processing court held that the term "investment company" should be understood as a term of art requiring corporations that qualify as

investment companies comply with certain regulations, including registration

with government agencies.  Automatic Data Processing, 313 Ill. App. 3d at 444.  We adopt the rationale employed by the Automatic Data Processing court in drawing a distinction between regulated and nonregulated investment companies for purposes of qualifying as a financial organization.  We will, however,

apply it to the uniformity clause challenge in the case sub judice.  

	Once a uniformity challenge is presented, the Department has the burden

to establish that there is a real and substantial difference between those

taxed and those not taxed and that the tax classification bears some

reasonable relationship to the object of the legislation or to public policy. 

Allegro Services, Ltd. v. Metropolitan Pier & Exposition Authority, 172 Ill. 2d 243, 250-51, 665 N.E.2d 1246 (1996).  The uniformity clause does not

require perfect rationality as to each taxpayer.  Rather, it imposes only

minimum standards of reasonableness and fairness between groups of taxpayers. 

Zunamon v. Zehnder, 308 Ill. App. 3d 69, 78, 719 N.E.2d 130 (1999).  The legislature, therefore, possesses "wide latitude" in selecting tax

classifications.  Zunamon, 308 Ill. App. 3d at 78.  In evaluating a uniformity clause challenge, we must presume that the taxing statute is constitutional,

and the party challenging it bears the burden of showing that the

classification is arbitrary or unreasonable, and if a set of facts can

reasonably be conceived that would sustain the classification, it must be

upheld.  Allegro Services, Ltd., 172 Ill. 2d at 250-51.  In the instant case, we find that the Department has shown that there is a real and substantial

difference between those taxed and those not taxed and that the tax

classification bears some reasonable relationship to the object of the

legislation and public policy.

	This court has upheld classifications similar to the one challenged here

under the uniformity clause.  In Square D Co. v. Johnson, 233 Ill. App. 3d 1070, 599 N.E.2d 1235 (1992), the taxpayer there challenged the distinction

drawn between aircraft owned, and not used for generating a profit, by a

private corporation and that which was used to generate a profit by carriers

for hire.  The latter received a use tax exemption where the former did not. 

Square D, 233 Ill. App. 3d at 1082-83.  There we held that although both groups performed the same activity, there existed a significant difference

between them because one was engaged in a profit-generating activity and was

subject to various other taxes and fees, whereas the other did not fly solely

to generate a profit.  Square D, 233 Ill. App. 3d at 1082-83.  

	Here, we are presented with the same scenario that was raised in Square D.  Taxpayer and a regulated investment company both invest money in securities.  However, regulated investment companies earn income by charging

fees and commissions for their services to the public.  ZIH does not charge

fees or commissions to taxpayer for its role in investing the funds. 

Furthermore, ZIH earns its income by collecting interest realized on the

principle placed into a professionally managed fund. 

	We reject taxpayer's challenge because regulated investment companies,

as was the case in Square D with passenger airlines, are subject to enhanced scrutiny by the regulatory agencies and additional financial burdens relative

to that regulation.  Accordingly, taxpayer has neither shown that ZIH should

be classified as a financial organization nor that the classification is

arbitrary or unreasonable.  

VII. Conclusion

	We hold that taxpayer failed to show by clear and convincing evidence

that ZDI and ZII should be excluded from its unitary group.  More

specifically, the trial court's finding that activities within the United

States were substantial and should have been included in the payroll

calculation for purposes of the 80/20 rule was not against the manifest weight

of the evidence.  We also hold that the taxation of ZIH's income to the extent

that it was minimally connected to Illinois did not violate the due process

and commerce clauses of the United States Constitution.  Further, ZIH's income

was business income that was taxable on an apportioned basis in Illinois to

the extent that it was used to effectuate the acquisition of Brooks, but the

remaining funds not used to acquire corporations were nonbusiness income, even though they were available for use in corporate acquisitions.  Finally, ZIH is

not considered a financial organization for purposes of apportioning its

income under section 1501(a)(8) of the Act (35 ILCS 5/1501(a)(8) (West 2000))

and the distinction drawn between regulated and nonregulated investment

companies does not violate the uniformity clause of the Illinois Constitution.

	For the foregoing reasons, the judgment of the circuit court is

affirmed.

	Affirmed.  

	GORDON, P.J., and SMITH, J., concur.