Opinion ID: 2181168
Heading Depth: 2
Heading Rank: 2

Heading: Gross-up and Fourteenth Amendment Due Process

Text: Though conceding that the income derived from foreign subsidiaries is part of its unitary business, NCR argues that taxation of its gross-up income contravenes the due process clause of the fourteenth amendment to the United States Constitution. [2] This is so, NCR contends, because whether or not it was taxed on gross-up depended solely upon its treatment of foreign taxes paid  i.e., as a credit or deduction on its federal return. Hence, NCR asserts that the gross-up amount created by its ... foreign tax credit election bears no `rational relationship' to its `interstate values' in Maryland. Brief at 15. Under both the Due Process and Commerce Clauses of the Constitution, a State may not, when imposing an income-based tax, `tax value earned outside its borders.' Container Corp. v. Franchise Tax Bd., 463 U.S. 159, 164, 103 S.Ct. 2933, 2939, 77 L.Ed.2d 545, 552, reh'g denied, 464 U.S. 909, 104 S.Ct. 265, 78 L.Ed.2d 248 (1983) (quoting ASARCO, Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 315, 102 S.Ct. 3103, 3108, 73 L.Ed.2d 787, 794 (1982)). Nonetheless, [i]t has long been established that the income of a business operating in interstate commerce is not immune from fairly apportioned state taxation. Mobil Oil Corp. v. Comm'r of Taxes, 445 U.S. 425, 436, 100 S.Ct. 1223, 1231, 63 L.Ed.2d 510, 520 (1980); also see Random House v. Comptroller, 310 Md. 696, 707, 531 A.2d 683, 688 (1987); Xerox Corp. v. Comptroller, 290 Md. 126, 128, 428 A.2d 1208, 1210 (1981). In order to challenge successfully State apportionment of corporate income, the taxpayer [must] ... prove `by clear and cogent evidence' that the income attributed to the State is in fact `out of all appropriate proportions to the business transacted ... in that State, ... or has led to a grossly distorted result....' Container Corp., supra, 463 U.S. at 170, 103 S.Ct. at 2942, 77 L.Ed.2d at 556 (quoting Moorman Mfg. Co. v. Bair, 437 U.S. 267, 274, 98 S.Ct. 2340, 2345, 57 L.Ed.2d 197, 205, reh'g denied, 439 U.S. 885, 99 S.Ct. 233, 58 L.Ed.2d 201 (1978)). NCR's argument that its gross-up meets this test relies principally on language extracted from F.W. Woolworth Co. v. Taxation and Revenue Dept., 458 U.S. 354, 372-373, 102 S.Ct. 3128, 3139, 73 L.Ed.2d 819, 833, reh'g denied, 459 U.S. 961, 103 S.Ct. 274, 74 L.Ed.2d 213 (1982): We need not be detained by New Mexico's reaching out to tax gross-up amounts that even the Supreme Court of New Mexico recognized as fictitious. ... The gross-up computation is a figure that the Federal Government deems Woolworth to have received for purposes of part of Woolworth's federal foreign tax credit calculation.... In this case the foreign tax credit arose from the taxation by foreign nations of Woolworth foreign subsidiaries that had no unitary business relationship with New Mexico. New Mexico's effort to tax this income deemed received  with respect to which New Mexico contributed nothing  also must be held to contravene the Due Process Clause. Id. [citations omitted]. But the reason the Supreme Court of the United States did not need to be detained by New Mexico's efforts to tax Woolworth's gross-up was not because, in that Court's view, State taxation of gross-up was unconstitutional per se. It was because a state cannot tax gross-up dividends, any more than it can tax actual dividends, when the foreign subsidiaries have no unitary business relationship with the state. Since the principle undergirding the holding in Woolworth was the absence of a unitary business relationship, the Court was not required to address the due process argument Woolworth directed at New Mexico's inclusion of gross-up. Woolworth is of no comfort to NCR; the unitary nature of NCR's business is conceded here. There are, of course, gross-up cases (or cases involving analogous principles) in which state courts have reached results favorable to the taxpayer by excluding gross-up (or other income includible in federal taxable income) from income subject to state taxation. See Dow Chemical Co. v. Comm'r of Revenue, 378 Mass. 254, 391 N.E.2d 253 (1979); Commonwealth v. Emhart Corp., 443 Pa. 397, 278 A.2d 916, appeal dismissed, 404 U.S. 981, 92 S.Ct. 451, 30 L.Ed.2d 364 (1971); In re Knosher, supra . There are also similar cases that hold in favor of the taxing authorities. See Ex parte Kimberly-Clark Corp., 503 So.2d 304 (Ala. 1987); Caterpillar Tractor Co. v. Lenckos, 84 Ill.2d 102, 49 Ill.Dec. 329, 417 N.E.2d 1343 (1981), appeal dismissed sub nom. Chicago, Bridge & Iron Co. v. Caterpillar Tractor Co., 463 U.S. 1220, 103 S.Ct. 3562, 77 L.Ed.2d 1402 (1983); Albany Int'l Corp. v. Halperin, 388 A.2d 902 (Me. 1978); Commonwealth v. Westinghouse, 478 Pa. 164, 386 A.2d 491, appeal dismissed, 439 U.S. 805, 99 S.Ct. 61, 58 L.Ed.2d 97 (1978). But the outcome in each of these cases turns on the specific provisions of a state statute, or on a reading of legislative intent in light of a particular legislative history or a given state's general approach to statutory interpretation. None addresses the fourteenth amendment issue that is now before us. One decision that does touch on that issue is Taxation & Revenue Dept. v. F.W. Woolworth, 95 N.M. 519, 624 P.2d 28 (1981), rev'd on other grounds, 458 U.S. 354, 102 S.Ct. 3128, 73 L.Ed.2d 819, reh'g denied, 459 U.S. 961, 103 S.Ct. 274, 74 L.Ed.2d 213 (1982). As is obvious from the citation (and as NCR points out), this decision was reversed by the United States Supreme Court. But as we have just observed, that reversal had nothing to do with any conclusion that a state would violate the due process clause of the fourteenth amendment if it taxed gross-up. The Supreme Court did not deal with that issue. The Supreme Court of New Mexico did at least touch on it, and seemed to find no constitutional impediment because Woolworth had received measurable economic benefit from its election to use the federal tax credit as opposed to a federal deduction for foreign taxes paid. Id. at 522-523, 624 P.2d at 31-32. And the Supreme Court of North Dakota has very recently reached the same conclusion. International Minerals & Chem. Corp. v. Heitkamp, 417 N.W.2d 791 (N.D. 1987). In Heitkamp, International Minerals & Chemical Corp. (IMC), a unitary business operating both within and without North Dakota and which owned a number of foreign subsidiaries, took the federal deemed paid credit. As in Maryland federal taxable income served as a tax base for state taxable income, but IMC tried to exclude the gross-up amount from its taxable North Dakota income. It made essentially the same constitutional argument that NCR submits to us. Observing, as we have, that the Supreme Court's Woolworth did not address the issue, the North Dakota court reasoned: A domestic corporation required to compute gross-up income under [26 U.S.C.] § 78 has received economic benefit from its election to take the § 902 foreign tax credit. By making this voluntary election, IMC has reduced its federal income tax liability.... In this case, it is conceded that IMC's foreign subsidiaries had a unitary business relationship with IMC and North Dakota. Therefore, the due process clause does not preclude North Dakota from taxing actual dividends IMC received from its foreign subsidiaries.... Having elected the benefit of the § 902 deemed paid foreign tax credit, IMC in effect chose not to deduct the foreign taxes paid by its foreign subsidiaries but to instead treat them as dividends and therefore gross income for purposes of the Internal Revenue Code.[ [3] ] We do not believe due process requires that IMC be freed from this choice for state tax purposes.... Because North Dakota does not statutorily recognize a deduction for § 78 gross-up income, IMC may not exclude the gross-up from the amount of federal taxable income reported on its state income tax return. Id. at 796 [citations omitted]. Heitkamp is on all fours with the case before us. We agree with the Supreme Court of North Dakota's reasoning, and for the same reasons, hold that the due process clause of the fourteenth amendment does not preclude Maryland from taxing NCR's gross-up income for tax year 1976.