Court: Appellate Court of Illinois; July 20, 1989; Illinois; State Appellate Court
Plaintiff Filtertek, Inc. appeals an order from the McHenry County circuit court, which upheld the Department of Revenue's decision imposing a tax deficiency of $167,881, including interest, for the years 1980 and 1981. The court determined that the Department's findings were factual and should be maintained unless proven contrary to the manifest weight of the evidence. Filtertek, a Delaware corporation with a manufacturing facility in Hebron, Illinois, specializes in plastic molded filters and employed around 180 workers, primarily in manufacturing, during the relevant years. Filtertek de Puerto Rico, a separately incorporated entity spun off from Filtertek in 1975, also employed approximately 180 individuals and was primarily engaged in the same industry. Both companies shared significant ownership and governance links, with over 50% of their Class A stock held by Hayden Leason, a Puerto Rico resident, who served as chairman for both firms. The companies conducted numerous intercompany transactions, including loans and product sales, with Filtertek purchasing about 90% of Puerto Rico’s output and handling distribution and sales for most of their products. Filtertek filed its Illinois income tax returns for 1980 and 1981, attributing its entire income to Illinois, and executed an agreement to extend the statute of limitations for tax assessments for 1980.
Three original documents were executed by the Department's auditor and retained by the Department without being sent to Filtertek. A Department of Revenue audit on October 8, 1984, reassessed Filtertek's Illinois tax liability, determining that Filtertek and its subsidiaries constituted a "unitary business," necessitating combined apportionment under section 304(a) of the Illinois Income Tax Act. The Department adjusted Filtertek's unitary business income and applied a statutory three-factor formula to determine that approximately 77% of the combined business income in 1980 and 64% in 1981 were subject to Illinois taxation. This resulted in tax deficiencies of $77,649 for 1980 and $90,232 for 1981. An administrative hearing upheld the deficiency on February 25, 1987, followed by a limited rehearing regarding the sales factor, which was further upheld on August 31, 1987. Filtertek filed a complaint for administrative review in McHenry County on October 2, 1987. The circuit court affirmed the Department’s decision on September 29, 1988, concluding it was not against the manifest weight of the evidence. The key issue on appeal is whether the finding of Filtertek as part of a unitary business group was supported by the evidence, which the court determined it was. The term "unitary business group" refers to interrelated corporate units operating in multiple jurisdictions, making it challenging for a state to allocate income to individual corporations for taxation purposes. Filtertek acknowledged the existence of a unified business structure but contested the adequacy of ownership for defining a unitary business group prior to the enactment of a specific statutory definition in 1983.
The Illinois Supreme Court has established that the term "unitary business group" applies not only to parent-subsidiary relationships but also to corporations with associated entities across states or countries. This interpretation includes scenarios where corporations are owned by an individual, as evidenced by the relationship between Filtertek and its subsidiaries. The court found sufficient evidence to classify the plaintiff as part of a unitary business group.
The subsequent issue involves income allocation for a recognized unitary business group. Filtertek argues that the three-factor test outlined in section 304 of the Act does not accurately reflect its business activities in Illinois, making it eligible for alternative allocation methods. However, the court maintains that section 304(a) mandates combined apportionment of income based on Illinois property, payroll, and sales relative to the total for the group, establishing a presumptive method for fair apportionment.
Filtertek claims that this statutory method results in inflated income figures for Illinois, having reported significant increases in income percentages over recent years. Nonetheless, the court requires Filtertek to provide clear justification for why the statutory formula yields distorted results, referencing regulatory standards that necessitate evidence showing unreasonable apportionment. While Filtertek pointed out that the applicable regulation was enacted after the relevant tax years, the court noted that the standard it established was already in effect. Ultimately, Filtertek bears the burden to demonstrate, with clear and cogent evidence, that the apportionment method disproportionately taxes income not connected to its business activities in Illinois.
Clear and cogent evidence is necessary for relief under section 304 of the Act. The hearing officer determined that Filtertek failed to provide such evidence to demonstrate that the three-factor formula did not accurately reflect its business activities in Illinois. Filtertek's Illinois operations included sales, marketing, research and development, contracting, manufacturing, and logistics, while Puerto Rico was responsible only for a portion of manufacturing. Filtertek's argument regarding lower costs in Puerto Rico affecting formula apportionment was deemed unconvincing, as its extensive activities in Illinois suggested that its income share was not grossly distorted. Consequently, Filtertek was not eligible for alternative allocation under section 304(e).
Filtertek also claimed that Illinois sales were inflated due to including sales receipts from Puerto Rican products sold to Filtertek and then resold out-of-state. The hearing officer found that sales from Puerto Rico to Filtertek were correctly excluded from the total sales denominator but included in the numerator for Illinois sales. According to the formula, sales are attributed to Illinois if made to Illinois customers or shipped from an Illinois location when the seller is not taxable in the purchaser's state. Filtertek argued that these were merely transshipped products, but the hearing officer found that Filtertek held title, was responsible for resale and storage, and managed delivery and quality issues, indicating these transactions represented more than temporary ownership. The next step is to confirm if the sales meet the taxability criteria under section 304(a)(3)(B)(ii), which require proof that the goods were shipped from Illinois and that Filtertek was not taxable in the purchaser's state.
Filtertek's argument regarding the immediacy of product reshipment and the relevance of storage duration was dismissed, as Illinois law requires only that goods be stored at an Illinois facility for some time, without a specified minimum duration. The hearing officer's decision that the goods were held in storage, even briefly, was upheld due to sufficient evidence. Furthermore, it was confirmed that Filtertek did not incur taxes in the destination states for the products, with its tax returns indicating that all sales were taxed in Illinois. Consequently, the sales were correctly included in the sales factor numerator.
Filtertek also claimed that a deficiency notice for 1980 should not be issued due to the expiration of the statute of limitations. The company argued that a signed extension agreement was invalid due to the Department's failure to communicate acceptance. However, the law allows for such extensions through mutual written agreements. Although the Department did not send a duplicate of the executed agreement, Filtertek was found to have accepted the Department's offer by executing and returning the agreement. This established a binding contract, negating Filtertek's claim about the lack of acceptance communication. The court concluded that there was a clear meeting of the minds, validating the extension of the notice period for deficiency issuance. Thus, the circuit court's judgment was affirmed.
