Opinion ID: 2140533
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Heading: Apportionment Formula

Text: When a corporation derives income from both Illinois and one or more other States, it becomes necessary to apportion the percentage of its income which may be taxed by this State. Section 3-304(c) of the Act (Ill. Rev. Stat. 1973, ch. 120, par. 3-304(c)) sets forth the one-factor formula to be utilized by a financial organization when making this determination. It provides in relevant part: (c) Financial organizations. Business income of a financial organization shall be apportioned to this State by multiplying such income by a fraction, the numerator of which is its business income from sources within this State, and the denominator of which is its business income from all sources. For the purposes of this subsection, the business income of a financial organization from sources within this State is the sum of:    (3) Interest and dividends received within this State;   . The apportionment formula, therefore, may be expressed as follows: Illinois Gross Receipts x Tax Base x 4% [] = Illinois Gross Receipts from (Business income tax all States Income) the interest is only used to distribute the tax base among jurisdictions in proportion to the percentage of business activity conducted in that jurisdiction. The Multistate Tax Commission, in support of this position, argues that inclusion of the interest earned on United States obligations is necessary to ensure the fundamental principle established by the drafters of the Division of Income for Tax Purposes Act (see Ill. Rev. Stat. 1983, ch. 120, par. 3-301 et seq. ). In GTE Automatic Electric, Inc. v. Allphin (1977), 68 Ill.2d 326, this court stated that [t]he purpose of the uniform act and article 3 of the Illinois act is to assure that 100% and no more or no less, of the business income of a corporation doing multistate business is taxed by the States having jurisdiction to tax it. 68 Ill.2d 326, 335. Under section 742 of title 31 of the United States Code (1976), [a]ll stocks, bonds, Treasury notes, and other obligations of the United States, shall be exempt from taxation by or under State or municipal or local authority. This exemption extends to every form of taxation that would require that either the obligations or the interest thereon, or both, be considered, directly or indirectly, in the computation of the tax, except nondiscriminatory franchise or other nonproperty taxes in lieu thereof imposed on corporations and except estate taxes or inheritance taxes. In Society for Savings v. Bowers (1955), 349 U.S. 143, 144, 99 L.Ed. 950, 955, 75 S.Ct. 607, 608, Mr. Justice Harlan stated: In 1829 this Court decided in Weston v. City Council of Charleston [27 U.S. (2 Pet.) 449, 7 L.Ed. 481], that obligations of the Federal Government are immune from state taxation. This rule, aimed at protecting the borrowing power of the United States from state encroachment, was derived from the `Borrowing' and `Supremacy' Clauses of the Constitution, and the constitutional doctrines announced in McCulloch v. Maryland [(1819), 17 U.S. 316 (4 Wheat.) 316, 4 L.Ed. 579.] It was subsequently embodied in a succession of federal statutes, the existing statute being R.S. section 3701, 31 U.S.C. section 742. The rule has been carried forward to embrace indirect taxation of such obligations through their inclusion in a tax imposed on all the property of a taxpayer. Until 1959, 31 U.S.C. section 742 only provided that obligations of the United States were exempt from taxation by or under State, municipal or local authority. In 1959, Congress amended section 742 by adding the second sentence of the section, quoted above. This addition emphasized the absolute prohibition of any consideration of such obligations, either direct or indirect, in the computation of a State or local tax. By including the interest received on United States obligations in the apportionment formula, the State, in this case, would do indirectly that which it is prohibited from doing directly. See Federal Products Corp. v. Norberg (R.I. 1981), 429 A.2d 447; First Federal Savings & Loan Association v. Department of Revenue (Mont. (1982), 654 P.2d 496, cert. denied (1983), 462 U.S. 1144, 77 L.Ed.2d 1378, 103 S.Ct. 3128. In American Bank & Trust Co. v. Dallas County (1983), 463 U.S. 855, 77 L.Ed.2d 1072, 103 S.Ct. 3369, the court considered a State bank-shares tax based on an equity-capital formula. The formula computed the tax on the basis of the difference between a bank's capital assets and liabilities. The court held that the tax was violative of section 742 because such a tax takes into account, at least indirectly, the federal obligations that constitute a part of the bank's assets. (463 U.S. 855, 863, 77 L.Ed.2d 1072, 1079, 103 S.Ct. 3369, 3374.) In a strongly worded opinion, the court emphasized that 31 U.S.C. section 742, as amended in 1959, is sweeping[,]    `extend[ing] to every form of taxation that would require that either the obligations or the interest thereon, or both, be considered, directly or indirectly, in the computation of the tax.' (Emphasis in original.) (463 U.S. 855, 862, 77 L.Ed.2d 1072, 1078, 103 S.Ct. 3369, 3374.) Further, [u]nder the plain language of the 1959 amendment,    the tax is barred regardless of its form if federal obligations must be considered, either directly or indirectly, in computing the tax. (Emphasis in original.) 463 U.S. 855, 862, 77 L.Ed.2d 1072, 1079, 103 S.Ct. 3369, 3374. Including tax-exempt interest on United States obligations in the apportionment formula outlined in section 304(c) of the Act results in the indirect (at a minimum) consideration of a Federal obligation in the computation of a State tax. It is impossible to reconcile this approach, as taken by the State and the Multistate Tax Commission, with the express prohibition of 31 U.S.C. section 742 (1976) and the illuminating interpretation of section 742 opined in American Bank & Trust Co. We do find that it is possible to apply the section 304(c) apportionment formula without running afoul of the supremacy clause of the United States Constitution (art. VI, cl. 2) as well as article I, section 8, which provides Congress with the power [t]o borrow money on the credit of the United States. U.S. Const., art. I, sec. 8, cl. 2. Section 304(c)(3) of the Act (Ill. Rev. Stat. 1973, ch. 120, par. 3-304(c)(3)) instructs the taxpayers to include [i]nterest and dividends received within this State in the apportionment formula. The State maintains that the clear language of this provision mandates the inclusion of tax-exempt, as well as taxable, interest received within Illinois. We do not agree. The purpose of the apportionment formula is to confine the taxation of business income to that portion which is attributable to activities in Illinois. ( Caterpillar Tractor Co. v. Lenckos (1981), 84 Ill.2d 102, 123, appeal dismissed sub nom, Chicago Bridge & Iron Co. v. Caterpillar Tractor Co. (1983), 463 U.S. 1220, 77 L.Ed.2d 1402, 103 S.Ct. 3562.) It is illogical to assume that the General Assembly would devise a formula to measure taxable income which includes income that is clearly tax-exempt. We conclude, therefore, on the basis of the relevant Federal statute (31 U.S.C. sec. 742 (1969)) and the recent decision of the Supreme Court in American Bank & Trust Co. v. Dallas County (1983), 463 U.S. 855, 77 L.Ed.2d 1072, 103 S.Ct. 3369, that tax-exempt interest income on obligations of the United States may not be taken into consideration in apportioning taxable income. As such, the judgment of the appellate court on the apportionment issue is affirmed. The judgment of the circuit court of Cook County is affirmed as to the amortization and apportionment issues. Also, since the bank has not challenged the appellate court's reversal of the circuit court as to the penalty issue, the appellate court is affirmed in that regard and the circuit court is reversed. Appellate court affirmed in part and reversed in part; circuit court affirmed in part and reversed in part.