Opinion ID: 2224697
Heading Depth: 1
Heading Rank: 4

Heading: Sources within Indiana

Text: The statute does not define income derived from activities or businesses or any other sources within Indiana. In the Tax Court, Judge Fisher read the imposition statute against the background of its interpreting regulation, the history of situs analysis, and judicial treatment of taxes on income from intangibles. [5] He explained: [T]he case law analysis focuses on the relationship between the intangible and the taxpayer's business situs by identifying activities related to the critical transaction, here, the sale of an intangible giving rise to income, and then determining whether the degree of activities related to the critical transaction is sufficient to uphold taxation in Indiana. When activities related to the critical transaction occur at more than one situs, the dispositive inquiry therefore asks what degree of activity was regularly conducted at the different locations, i.e., are the activities more than minimal, not remote and incidental to the critical transaction. ... . The integral analysis [under the departmental regulation] therefore weighs the degree of related activity at a business situs to determine if it is more than minimal and not remote or incidental to the transaction giving rise to the income... . Bethlehem Steel, 597 N.E.2d at 1336-37 (citations omitted). Employing this scheme, Judge Fisher analyzed the relationship between the transactions producing the gross income and Bethlehem's activities in Indiana and held that the sales of tax benefits were not sufficiently related to Bethlehem's business activities at Burns Harbor to support the Indiana tax. We generally approve Judge Fisher's reading and application of the statute. A. The Interpreting Regulation. The Department's regulation, 45 I.A.C. 1-1-51, provides two tests for determining when intangible income derives from an Indiana activity, business, or source. First, the business situs test provides that if the taxpayer has established a business situs in Indiana, and the intangible forms an integral part of a business regularly conducted at [that] situs, then the intangible has an Indiana situs for tax purposes. Second, the commercial domicile test holds that if the taxpayer has established its commercial domicile in Indiana, then all of the income from intangibles will be taxed ... except that income which may be directly related to an integral part of a business regularly conducted at a `business situs' outside Indiana. If the taxpayer has established its commercial domicile in another state, then no income from intangibles will be taxed ... unless the taxpayer has also established a business situs in Indiana and the intangible income derived therefrom forms an integral part of that Indiana activity. Id. In the present case, the Department and Bethlehem agree that Bethlehem is commercially domiciled in Pennsylvania. The parties also agree that Bethlehem enjoys a business situs at its Burns Harbor Plant in Indiana. Thus, Indiana may not tax Bethlehem's income from the sales of the tax benefits unless the sales form an integral part of Bethlehem's in-state business activities. While the regulation does not explain when an intangible or the income from an intangible forms an integral part of a business operation, the Department did not construct its situs approach from whole cloth. The analysis was derived from the property tax context, [6] and an understanding of this history provides insight into the meaning of this language. B. The History of Situs Analysis. The long-established rule for taxing tangible property, mobilia sequuntur personam, held that such property followed the person of the owner. Under this rule, the owner's domicile had the sole authority to tax his personal property. A subsequent exception permitted the state in which the property was kept or used to levy a property tax. These were not competing rules, but a rule and its exception. The property still had only one situs for tax purposes, and only one state had the authority to tax. In Wheeling Steel Corp. v. Fox, 298 U.S. 193, 56 S.Ct. 773, 80 L.Ed. 1143 (1936), the Supreme Court applied this rule to intangibles, holding that due process demanded that intangibles be taxed only at the legal domicile of the owner. [7] This rule was subject to an exception, however, where the intangible had acquired a situs at the owner's commercial domicile. The Court upheld the commercial domicile's ad valorem property tax on the accounts receivable and bank deposits of a corporation legally domiciled in another state. The Court affirmed the proposition that `choses in action may acquire a situs for taxation other than at the domicile of their owner, if they have become integral parts of some local business.' Id. at 210, 56 S.Ct. at 777 (quoting Farmers' Loan & Trust Co. v. Minnesota, 280 U.S. 204, 50 S.Ct. 98, 74 L.Ed. 371 (1930)). The Indiana Supreme Court had already recognized this doctrine in Miami Coal Co. v. Fox (1931), 203 Ind. 99, 176 N.E. 11, holding that Indiana could not levy a property tax on the accounts receivable of an Indiana corporation where those intangibles were an integral part of the business operations of an Illinois branch of the corporation. The taxpayer owned and operated coal mines in Indiana, with its management offices in Illinois. The Court observed that the Illinois office made the sales, accepted payment on the sales, set the prices, consummated the contracts, paid the Indiana employees, and ordered the shipments. Comparing the two operations, the Court held that the intangibles had their situs in Illinois, not Indiana: Inasmuch as the business of appellant at its office in Chicago has gained a business situs, the bills and accounts receivable are a part of and so intertwined with and affixed to the business of appellant at its foreign office, that a taxing unit in Indiana may not reach into a business situs in Illinois and grasp the intangible thing which is so affixed to a business that it is a part and parcel of it. Id. at 112-13, 176 N.E. at 16. Significantly, the Court in Miami Coal did not base its decision on the location of the account records or on the fiction that the accounts receivable had some physical location. The Court looked at all of the circumstances and activities surrounding the property in order to determine its tax situs. Similarly, the Department's modern regulation states: The physical location of the intangible at the time any income is received under either the `business situs' test or the `commercial domicile' test is not a controlling factor but will be considered in view of all of the facts presented. 45 I.A.C. 1-1-51. Of course, Miami Coal involved a property tax, and the Court of Appeals subsequently questioned whether it presented a valid approach for analyzing a gross income tax problem. In Indiana Dep't of State Revenue v. Sohio Petroleum Co. (1976), 170 Ind. App. 123, 352 N.E.2d 95, overruled on other grounds, Indiana Dep't of State Revenue v. Harrison Steel Castings Co. (1980), Ind. App., 402 N.E.2d 1276, the court held that Indiana could impose its gross income tax on dividends paid from one Indiana corporation to another even where the shares of stock were held out of state. The court issued its holding in spite of Department regulations prohibiting the taxation of shares of stock with legal situs outside Indiana and criticized the Department for muddy[ing] the waters by engraft[ing] the Miami Coal business situs rule for personal property tax onto the gross income tax. Id. at 132, 352 N.E.2d at 100-01. Certainly, the Department may not issue regulations inconsistent with the statute which it is administering, but the defect in the regulation at issue in Sohio was its reliance on the physical evidence of the intangibles to establish their tax situs. [8] This was not the mode of analysis in Miami Coal. Instead, the Court compared the Indiana and Illinois activities that contributed to the production of the accounts receivable and determined that the intangibles were too closely tied to the sale of coal in Illinois to permit the Indiana tax. Similarly, in the income tax context, we look to the whole of the income-producing transaction  the actors, activity, and property  and weigh the in-state and out-of-state elements to determine if the intangible has an Indiana tax situs. C. Judicial Treatment of Taxes on Income from Intangibles. The Court of Appeals has employed this analysis in determining the taxability of the income from intangibles. [9] See Indiana Dep't of State Revenue v. J.C. Penney Co. (1980), Ind. App., 412 N.E.2d 1246; Indiana Dep't of State Revenue v. Convenient Indus. of Am. (1973), 157 Ind. App. 179, 299 N.E.2d 641. These precedents establish that whether a nondomiciliary's gross income from an intangible derives from an Indiana source depends on the relationship between Indiana and the actors, activities, and property creating the income. Indiana may not tax nondomiciliaries where the relation between Indiana and the subject of the tax is merely remote or incidental to the interstate transaction. J.C. Penney, 412 N.E.2d at 1248, 1252. The Indiana connection must be at least more than minimal. Convenient Indus., 157 Ind. App. at 185, 299 N.E.2d at 645. In Convenient Industries, the Department attempted to tax an out-of-state corporation on the proceeds from the sale of food mart franchises in Indiana. Specifically, the Department wanted to tax the proceeds from the service and advertising fees received from Indiana franchisees. [10] The Court of Appeals held for the corporation, concluding that the Indiana activities associated with the fees were minimal in comparison to the activities conducted out of state. The court announced that [t]he activities contemplated by the statute must be more than minimal, explaining that [i]f it were otherwise, the statute itself would promote cumulative tax burdens upon interstate commerce contrary to the Constitution. Convenient Indus., 157 Ind. App. at 185, 299 N.E.2d at 645. Applying this standard to the facts, the court compared the in-state and out-of-state activities that produced the proceeds. Regarding the service fees, the court found that supervisory inspections and an occasional report sent from Indiana to the main office in Kentucky were not sufficient to permit the tax. Regarding the advertising fee, the court found that the window banners and displays given to the Indiana franchisees represented only a fraction of the advertising fee. Again, the court held these connections insufficient for tax purposes. Similarly, in J.C. Penney, the court dealt with a gross receipts tax on an out-of-state corporation. The Department attempted to tax an out-of-state corporation's gross proceeds from direct mail catalog sales and service charges on credit sales in Indiana. [11] The corporation owned and operated retail and warehouse facilities in Indiana and advertised extensively in the state. Despite these connections with Indiana, the court held that proceeds from the catalog sales and service charges were the product of interstate, not intrastate, commerce and were not derived from an Indiana source. J.C. Penney, 412 N.E.2d at 1250, 1252. For our purposes, the treatment of the intangible service charges is most important. The trial court in J.C. Penney had found that the service charge income was income earned by a non-domiciliary corporation upon intangibles outside Indiana. Id. at 1251. As in Convenient Industries, the Court of Appeals compared the in-state and out-of-state elements of the income-producing transactions and noted that the out-of-state offices of the taxpayer kept the accounts and records, mailed account statements directly to the customers, collected payments directly from the customers, fielded inquires from customers, and collected on delinquent accounts. The court then stated: On the basis of these facts, the trial court was justified in concluding that the local activities with respect to the credit service income were remote and incidental. Id. J.C. Penney suggests continued vitality for situs analysis, even where a taxpayer enjoys a substantial Indiana presence. The decision in Indiana Dep't of State Revenue v. General Foods Corp. (1981), Ind. App., 427 N.E.2d 665, stands in accord. In General Foods, the court isolated the specific income-producing activities in determining whether the Department could tax the gross receipts from the sale of goods by an out-of-state corporation to Indiana customers. While the corporation operated a distribution and sales office in Indiana, the court found that the particular sales at issue were not closely enough related to these Indiana activities to constitute income derived from an Indiana source. The out-of-state offices made the sales, received the proceeds, solicited most of the orders (though some orders were solicited in Indiana by out-of-state representatives), accepted the orders, and shipped the goods from their out-of-state warehouses and factories. Id. at 666-67. The court concluded that the Indiana activities were merely incidental to [the corporation's] total operation and were therefore insufficient for the Department to seize upon in attempting to apply I.C. § 6-2-1-2 [currently Ind. Code Ann. § 6-2.1-2-2(a)(2)]. Id. at 670.