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Conoco, Inc. and Intel Corporation v. Taxation and Revenue Department, No. 22,995 (11/26/96). The taxpayers are multinational corporations that do business in New Mexico. Both taxpayers have numerous domestic and foreign subsidiaries. However, none of the taxpayers' foreign subsidiaries conduct business in New Mexico. New Mexico uses the standard three-factor formula to apportion a multijurisdictional taxpayer's base income to the state. However, corporations filing returns in New Mexico may elect one of four filing methods: separate accounting, separate corporate entity, combination of unitary corporations, or federal consolidated group. The taxpayers in this case chose to use the separate corporate entity method, under which the three-factor apportionment formula is applied to the entity's entire income.
New Mexico, like most other states, starts with a taxpayer's federal taxable income to determine income for state income tax purposes. The state allows corporations to take deductions for dividends paid by domestic subsidiaries, in accordance with the Internal Revenue Code. Dividends from foreign subsidiaries, however, are included in a taxpayer's federal taxable income, and are therefore included in the taxpayer's base income for state purposes. Unlike the federal government, New Mexico does not provide a credit for taxes paid to foreign governments; however, the state does employ the so-called "Detroit formula" to reduce the state taxable income base by adding into the denominators of the parent corporation's property, payroll and sales a portion of the dividend producing foreign corporation's property, payroll and sales. The portion is determined by dividing the net dividends received by the parent, by the foreign subsidiaries' net profits. Adding these divisors, the apportionment formula ultimately lowers the multiplier used against a taxpayer's total income, which in turn lowers its New Mexico tax base.
The New Mexico Supreme Court ruled that despite the use of the "Detroit formula," the state's apportionment method discriminates against foreign commerce under the Foreign Commerce Clause of the federal constitution, as interpreted by the U.S. Supreme Court in Kraft General Foods v. Iowa Department of Revenue, 505 U.S. 71 (1992). The Detroit formula, the court ruled, is an insufficient remedy to cure the initial discrimination of excluding domestic, but not foreign dividends from a taxpayer's base income, because the formula does not remove all of the dividends paid by a foreign subsidiary from it's parent corporation's tax base. The discriminatory effect is only minimized by the relative efficiency of a parent corporation's domestic and foreign subsidiaries. For example, if the economic efficiency of a taxpayer's foreign operations exceeds that of its domestic counterparts, the taxpayer's New Mexico income tax is increased. Moreover, the fact that the taxpayer chose to use the separate entity method of reporting income, rather than the domestic combined reporting formula that the High Court implicitly approved in Kraft, does not mean that constitutional infirmity of the separate entity method is of no moment. The courts cannot ignore constitutional challenges merely because the taxpayer could have chosen another, constitutionally firm option to report income.
Nexus
Ruling of Commissioner, P.D. 96-213, Virginia Department of Taxation (8/26/96). The Commissioner ruled that the out-of-state taxpayer, who delivered merchandise sold by its resident sales force into Virginia using its own trucks, was required to file Virginia income tax returns because the taxpayer's activities in the state exceeded mere solicitation. The taxpayer's deliveries into the state were more than de minimis, the Commissioner found, and moreover, the taxpayer's installation and servicing of its product constituted a regular and continuing presence in the state.
House of Lloyd v. Department of Revenue, No. 36 F.R. 1991 (Pa. Commw. Ct. 10/28/96). The taxpayer is a Missouri corporation with no facilities, real property, or regular employees in Pennsylvania. The taxpayer markets its products through a network of independent district managers, supervisors, distributors and hostesses. The taxpayer provides its distributors and hostesses with sample product kits, catalogues, order forms and prizes awarded to distributors and hostesses for successful sales and promotional activities. The taxpayer retained ownership of the sample kits until (1) awarded to a representative for meeting a specified sales quota; (2) a representative purchased a sample kit from the taxpayer; or (3) the kit was returned to the taxpayer. The commonwealth court ruled that the taxpayer was liable for use tax on the products used in Pennsylvania, because the taxpayer's activities in the state, through the direction and control of its large sales network, constituted the required substantial nexus to support the imposition of use tax liability.
Federal Contractors
Tax Injunction Act
United Technologies Corporation v. Commissioner of Revenue Services, 238 Conn. 761 (Conn. Sup. Ct. 8/13/96). Connecticut's highest court ruled that the taxpayer was not subject to sales tax on tangible personal property purchased on behalf of the federal government to fulfill contractual obligations, but was liable for tax on services purchased in the course of carrying out its contractual obligations. The taxpayer was hired by several federal agencies to develop methane fuel cells on a cost-plus basis. The terms of the contract stated that title to all tangible personal property purchased by the taxpayer in the course of fulfilling the terms of the contract were to vest immediately in the federal government. In addition, the taxpayer was required to use the property only for the performance of its contractual duties, and was accountable and responsible for all properties purchased. The federal government reserved its right of access to the property at all times, and relieved the taxpayer from any duty to insure the property as well as any liability for damage. Finally, the federal government required the taxpayer to dispose of purchased property according to instructions from the government. Given the instant set of facts, the court found that the federal government itself took title to the property acquired in connection with the taxpayer's contracts. The court looked to such factors as the requirement that the taxpayer comply with government property regulations, the fact that the agreement stipulated that title to property purchased vested immediately in the government, and the government's payment of all shipping and handling costs for transporting the purchased property to the taxpayer's facilities.
The court came to the opposite conclusion with respect to the taxpayer's purchases of services, however. The Connecticut statute imposing sales tax on services focuses on acceptance, and even though the federal government exercised some contractual control over the taxpayer's purchases, there was no question that it was the taxpayer, not the federal government, who purchased and consumed the services.
Use Tax
Catalogue Distribution
Talbots, Inc. v. Schwartzberg, et al., No. 95CA 1892 (Colo. Ct. App. 10/24/96). The Colorado Court of Appeals ruled that an out-of-state corporation is subject to use tax on catalogues mailed to Colorado residents. The taxpayer is a Delaware corporation with two retail stores in Denver. It contracted with a non-Colorado printer to print its catalogues and mail them world-wide. The taxpayer sent approximately 5,000 catalogues to its Denver stores, on which it paid use tax. Thirty thousand catalogues were sent to other Denver addressees, on which no use tax was paid. The taxpayer claimed that the use tax assessment on these catalogues was invalid because the activity on which the assessment was levied took place wholly outside of the taxing jurisdiction.
The court observed that in the present case, the taxpayers are in the same situation that presented itself to the U.S. Supreme Court in D.H. Holmes v. McNamara, 486 U.S. 24 (1988), where the Court upheld Louisiana's imposition of use tax on catalogues mailed to Louisiana residents from an out-of-state printer/distributor, where the taxpayer had presence in the state in the form of retail outlets. The Holmes Court found that because the taxpayer had offices and stores in Louisiana and engaged in other activities as well, the taxpayer enjoyed the benefits of the state's infrastructure so as to support the use tax levy. The reasoning of the Holmes case applies with equal force to the case at bar, the Colorado court concluded. Because the taxpayer has retail stores in Denver, and enjoys the infrastructure provided by the City of Denver and the State of Colorado, the City's use tax on catalogues mailed to Denver residents is justified.
Service Merchandise Company, Inc. v. Arizona Department of Revenue, No. TX 92-00002 (Ariz. Ct. App. 10/3/96). The Arizona Court of Appeals ruled that the taxpayer, a Tennessee corporation with two retail establishments in Arizona, was liable for Arizona use tax on catalogues and fliers printed by an out-of-state concern and distributed to Arizona customers. The taxpayer designs its catalogues and fliers at its home offices in Tennessee, and contracts with non-Arizona printers to produce the catalogues and fliers. Distribution to Arizona customers is accomplished in one of two ways: The taxpayer arranges for the out-of-state printer to ship the goods via common carrier to a U.S. postal facility in Phoenix, where they are subsequently delivered to Arizona customers; or, the taxpayer directs the printer to mail the catalogues and fliers directly to Arizona addresses from postal facilities at the printer's location.
The Court of Appeals ruled that the taxpayer "used" the catalogues and fliers in Arizona within the meaning of the state's use tax statute, since it specifically includes "the exercise of any right or power over tangible personal property incidental to owning the property" as a taxable use. Distribution of the catalogues in the state, the court said, was an act incidental to ownership statute, even though the distribution contracts were consummated outside the state. The right to control when, how, where, and to whom the catalogues and fliers would be delivered were exercised in Arizona through the taxpayer's agents, and therefore fell within the statute's definition of "use." The court further ruled that the tax was fairly apportioned because it does not apply to property whose sale or use has been subjected to another state's tax. Finally, the tax is justified because the state's infrastructure benefits the taxpayer by enabling customers to travel to the taxpayer's retail outlets to order and receive catalogue items.
Class Actions
Arkansas Department of Revenue v. Staton, No. 96-215 (Ark. Sup. Ct. 10/28/96). In 1994, the taxpayer purchased a motor vehicle and an extended warranty service contract. She paid sales tax on both the vehicle and the warranty contract. The taxpayer filed a refund claim for the sales tax paid on the contract, arguing that extended warranty service contracts are not taxable because no taxable event (i.e., repair services) had been performed at the time of purchase. The taxpayer also sought class certification for all similarly situated taxpayers. Certifying the class, the chancery court ruled that the warranty contracts were not taxable, because an extended warranty is not "service" of a motor vehicle within the meaning of the statute. State law imposes sales tax on the gross receipts derived from any and all sales of auto repair services. Here, the repairs are completely contingent upon events that may never occur. Therefore, the purchase of an extended warranty contract does not qualify as the service or repair of an automobile.
The state supreme court agreed with the chancellor that the extended warranty service contracts were not taxable. However, the court ruled that the chancellor erred in certifying this matter as a class action suit, because it had no jurisdiction over the remaining class of taxpayers. The Arkansas Constitution provides that the state cannot be sued in its own courts, except in limited circumstances. One of these circumstances is where a taxpayer sues for refund of sales taxes erroneously assessed and collected by the state. However, the statutory procedure governing such claims is very strict, allowing a taxpayer to sue for refunds only after a claim has been filed and refused, or not acted upon by the Commissioner. Full compliance with the statute must be had before the sovereign immunity of the state is waived. In the present case, the taxpayer's claim was the only one filed and rejected by the state. Therefore, the state's sovereign immunity was waived only with respect to the taxpayer's case. Because no other taxpayer filed a claim with the Department, the trial court did not acquire jurisdiction over other taxpayers who may have similar claims, but who chose not to file suit for refund of the taxes paid in error.
Exemption - Sale for Resale
School Calendar Company, Inc. v. Huddleston, Nos. 03A01-9603-CH-00090 and 03A01-9603-CH-00091, (Tenn. Ct. App. 7/18/96). The Tennessee Court of Appeals rebuffed the Department of Revenue's attempt to impose sales and use tax on the paper, ink and other supplies, as well as certain machinery purchased by the taxpayer, a Tennessee company that distributes calendars and pocket-sized schedule cards to schools and colleges. The taxpayer is a subsidiary of a general commercial printer. Though the taxpayer does not own a printing press, it contracts with its parent company to provide press time for its product. The taxpayer generates most of its revenue from advertisers and sponsors whose ads and/or names appear on the schedule cards and calendars produced by the taxpayer. The remaining revenue is derived from schools and colleges that purchase the taxpayer's wares. In only a few cases, however, will the educational institution pay the full contract price for the schedule cards and calendars. Some institutions raise the funds from the surrounding community, but most take advantage of the taxpayer's offer to contact potential advertisers and sponsors to finance the cost of the calendars and schedule cards. Even though an advertiser or sponsor may be found, it is not uncommon for the schools to have to make up the difference between the cost of the product selected by the institution and the funds secured from advertisers and sponsors.
The state argued that tax is due because the taxpayer merely sells advertising for the calendars and schedule cards, but distributes the final product without charge. Because the taxpayer does not sell its product, it is responsible for sales and use tax on the paper, ink and other supplies used to manufacture the goods. The taxpayer disputed the state's assertion that it was merely an advertising agency, arguing that it in fact sells its wares for consideration, and is thus entitled to a sale for resale exemption under state law.
The pivotal question in this case, the court observed, is whether the taxpayer is actually selling its product. If so, then the taxpayer's purchases of materials constitute sales for resale, and are exempt from tax. If not, then the taxpayer's purchases are taxable. The court first noted that there in fact exists a contractual relationship between the taxpayer and a school, based on a set price for the total number of products ordered. The court also noted that the schedule cards and calendars are not shipped to the school "unless and until" the full contract price is paid. While it is true that in most cases the contract price is paid through advertising or sponsorships, and that the advertisers and sponsors are obtained by the taxpayer acting on behalf of the school, the court declared that it could not see how the mode of securing funds for the taxpayer's products-whether by the school directly or by the taxpayer acting on the school's behalf-affects the issue of whether there has been a sale of tangible personal property as contemplated by the state sales tax law. Under the statute, the term "consideration" is not defined in a manner that limits the concept to direct payments from the schools. Absent indication to the contrary in either the statute or the statute's legislative history, the court saw no reason why the concept of "consideration" could not include funds secured from other persons, be they advertisers, sponsors, or the community at large, especially where the school has contracted to take the taxpayer's products at a specified price.
In addition, the court noted that in most cases, the school itself does pay at least a portion of the contract price. Therefore, the court concluded, there exists ample evidence to show that the taxpayer sells its products to schools and other educational institutions for "consideration" and is entitled to the sale for resale exemption.
Internet
Bensusan Corp. v. King, No. 96 Civ. 3992 (S.D.N.Y. 9/9/96). A New York District Court ruled that the defendant, a Missouri resident, did not have sufficient Due Process Clause nexus with New York to support personal jurisdiction in New York federal courts. The defendant created an Internet World Wide Web site, advertising his Missouri jazz club with information on how to order tickets to performances. The plaintiff sued on grounds of trademark infringement. The district court ruled that it did not have the power to entertain the matter, declaring that establishing an Internet Web site that was forseeably accessible by New Yorkers did not establish the minimum connection with New York necessary to support personal jurisdiction over the defendant. To establish a minimum connection under the Due Process Clause, the court said, it must be determined (a) whether the defendant purposefully availed himself of the benefits of the forum state; (b) whether the defendant's conduct and connection with the forum state are such that he should reasonably be hauled into court there; and (c) whether the defendant carries on a continuous and systematic part of its general business within the forum state. Applying these factors to the instant matter, the court concluded that the defendant had done nothing to purposefully avail himself of the benefits of New York state. Rather, the defendant "simply created a Web site, and permitted anyone who could find it to access it. Creating a site, like placing a product into the stream of commerce, may be felt nationwide-or even worldwide-but, without more, it is not an act purposefully directed toward the forum state."
Note: Though not a tax case, Bensusan is of no little import to state tax administrators, who are now engaged in efforts to impose sales and use tax on goods sold over the Internet. If the reasoning of the court is correct-that Due Process nexus does not result from the mere creation of a Web site by an out-of-state solicitor-it is almost certain that absent other nexus-creating factors, Commerce Clause nexus cannot be established either. This puts vendors selling product via the Internet in the same category as the "pure vanilla" direct-mail vendors (i.e., those vendors that have no physical presence or engage in other activities that create substantial nexus with the taxing state), who cannot be constitutionally required to collect and remit use tax on goods sold to in-state residents.
Burlington Northern Railroad Co. v. Department of Revenue, No. 95-1316 (10th Cir. 8/26/96). The 10th Circuit ruled that Colorado could not include the value of an interstate railroad's computer software in the taxpayer's ad valorem property tax assessment under the 4-R Act. Colorado law in general exempts from property tax the value of intangible personal property, including that of computer software. This exemption, however, does not apply to the intangible personal property owned by utilities, which in Colorado, includes railroads. Relying on the 1994 U.S. Supreme Court decision in ACF Industries v. Oregon Department of Revenue, 510 U.S. 332 (1994), (where the High Court held that the anti-discrimination provision of the 4-R Act does not generally apply to a system of exemptions), the state denied the taxpayer's request for refund. The 10th Circuit reversed, noting that ACF Industries Court also recognized that a tax exemption denied to a specific and isolated group of taxpayers might violate the 4-R Act. This is such a case, the court found, because the exemption in question applies to all commercial and industrial property except public utilities. Moreover, the court pointed out, the tax is imposed only on a narrow group of taxpayers, specifically those who had interstate interests. Therefore, the state's intangible property tax exemption singled out the railroad as an isolated and targeted group for discriminatory treatment, and therefore violated the anti-discrimination component of the 4-R Act.
The dissenting appeals justices pointed out that all public utilities were denied the exemption. Therefore, the railroad should have been required to provide that the denial of the exemption singled out railroads, or alone as part of an isolated group. This could have been accomplished by the taxpayer with a showing that (a) it dominates the class of public utilities subject to tax, and could therefore be considered an isolated group when compared to the general class of commercial and industrial property exempt from the tax, and (b) the class of public utilities subject to the tax is primarily made up of foreign taxpayers such as the railroad.
Property
Military Personnel
Karsten v. Kansas Department of Revenue, Nos. 74,692, 74,694, 74,695, 74-696, 74,697 (Kan. Ct. App. 10/4/96). The Kansas Court of Appeals ruled that military personnel stationed in the state under military orders, but residents of other states, were not liable for the state's automobile personal property tax under the Soldier's and Sailor's Civil Relief Act of 1940. The Act protects the state of residence or domicile of military personnel for state tax purposes while living elsewhere under military orders. The purpose of the Act is to prevent the double taxation of the income and property of nonresident military personnel. Even though the personnel stationed in Kansas registered to vote (for purposes of voting in national elections) and registered automobiles in the state for convenience sake, these actions did not supersede the protections afforded under the federal law, the court ruled.
Exempt Organizations
New England Legal Foundation v. City of Boston, No. SJC-06995 (Mass. Sup. Jud. Ct. 9/24/96). Massachusetts' highest court ruled the taxpayer qualifies as an exempt organization and is therefore not required to pay local property taxes. The taxpayer is a corporation organized to provide legal representation on public interest matters and to engage in non-partisan test-case litigation on behalf of the general public. The taxpayer claimed that it was a tax-exempt charitable organization, but the City of Boston rejected this assertion, stating that the taxpayer was primarily engaged in political activities, and thus not entitled to a local property tax exemption. The Maine Supreme Judicial Court ruled in favor of the taxpayer, finding that it is in fact a charitable organization, and entitled to tax-exempt status. The court determined that the taxpayer met the requirements as a charitable organization, in that its dominant purpose involves work for the public good. Moreover, the taxpayer's charter, bylaws, and federal and state tax exempt treatment are evidence that the taxpayer meets the City's standards for a charitable organization. Finally, the court found that the taxpayer works for the public good, and that conducting test-case litigation is not a political activity.
Tax Injunction Act
U.S. v. Lewis County, WA, No. 95-35332 (9th Cir. 8/16/96). The 9th Circuit ruled that the Tax Injunction Act, 28 U.S.C. §1341, does not bar the federal government from bringing suit against a county that tried to impose a property tax on property owned by the Farmers Home Administration. The U.S. government brought suit in federal district court challenging the constitutionality of the county's property tax as it was applied to FmHA. The district court observed that the U.S. may sue in federal court on behalf of itself and its instrumentalities to protect itself from unconstitutional state tax practices. However, the court continued, where Congress has specifically authorized states to levy taxes on federal instrumentalities, as in the case of FmHA, the Tax Injunction Act specifically provides for a state rather than a federal forum if the state provides a plain, speedy and efficient remedy. Because a plain, speedy and efficient remedy could be had in Washington's courts, the district court ruled that it lacked subject matter jurisdiction over the federal government's suit.
The 9th Circuit reversed, finding that the district court did indeed have subject matter jurisdiction over the federal government's claim. The appeals court noted that the U.S. Supreme Court has held that the Tax Injunction Act does not require the U.S. and its instrumentalities to exhaust state remedies before proceeding on tax matters in federal court. This rule is not abrogated, the 9th Circuit said, simply because the federal government has consented to state taxation. Any waiver of sovereign rights of the federal government must be explicitly based on congressional enactment, and cannot be implied through other acts of the government. Thus, the federal government's consent to taxation of FmHA did not expressly waive its right to challenge that taxation in federal court.
Gross Receipts Tax
Federal Contractors
United States v. New Mexico, No. CIV 96-0099 LH/WWD (N.M. Dist. Ct. 8/21/96). A New Mexico federal District Court dismissed the federal government's suit against the state Department of Revenue challenging the Department's gross receipts tax levied on federal contractors building a hospital on an Indian reservation, finding that the claim was barred by the Tax Injunction Act (28 U.S.C. §1341 (1993). The court found that the U.S. government's suit was governed by the U.S. Supreme Court's decision in U.S. v. California, 507 U.S. 746 (1993). In that case, the High Court determined that the U.S. was not entitled to sue the California Board of Equalization for a refund of sales taxes paid, pursuant to contract, on behalf of a federal contractor. The High Court found that the federal government was merely a subrogee of its contractor (and therefore enjoyed no greater rights than the contractor would have enjoyed under state law). The contractor's original refund claim against the state had been dismissed earlier; moreover, the statute of limitations had run. Because the contractor would have been barred from bringing a refund claim, the federal government, as subrogee, was similarly barred from filing the identical claim on the contractor's behalf.
In the instant case, the New Mexico district court determined that the federal contractors would have been prohibited from filing the present action in federal court under the Tax Injunction Act. Since the federal government's right to litigate its contractors' state tax disputes derives through subrogation of the contractors' obligations to the state, if the contractors are barred from litigating in federal court, so must the federal government be likewise barred.
Airport Departure Tax
Tri-State Coach Lines, et al., v. Metropolitan Pier and Exposition Authority, No. 96 L 50112 (Ill. Cir. Ct. 5/22/96). The taxpayer operates airport limousine services from O'Hare and Midway Airports in Chicago, transporting airline passengers to destinations within and without Illinois. Some Chicago-bound passengers whose travel originated in other states prearrange for the taxpayer's transportation services before leaving their point of origin. Other passengers, through prearrangement or upon arrival at the Illinois airports, request to be taken to destinations outside the state. The Authority imposes an "airport departure tax" on all those providing ground transportation for hire within the metropolitan area. The taxpayer challenged the validity of the tax under §14505 of the Interstate Commerce Commission Termination Act of 1995, P.L. 104-88 (1995), which prohibits states from levying taxes or other fees on either passengers or transportation via motor carrier in interstate commerce. This section was intended to legislatively overturn the U.S. Supreme Court's decision in Oklahoma Tax Commission v. Jefferson Lines Inc., 115 S.Ct. 1331 (1995), where the Court ruled that a state could validly impose an unapportioned sales tax on bus tickets for interstate travel. The taxpayer argued that the term "interstate commerce" should be given the same broad construction as it has in the context of a constitutional challenge, which means that the section applies to prohibit any local tax on the motor transport of passengers traveling between states, even if the actual interstate travel is by air carrier, and the only transportation by motor carrier is prearranged intrastate travel.
The circuit court disagreed with the taxpayer's contention, finding that the federal statute in question was intended to remedy the particular "evil" wrought by the High Court in Jefferson Lines, i.e., allowing the local taxation of purely interstate motor travel. In enacting this provision, the court said, Congress was merely trying to "restore the same balance between interstate commerce and local taxation which had been fixed by the [U.S. Supreme Court's] constitutional interpretation of the Commerce Clause prior to Jefferson Lines." Because the exclusive focus of Congress was on motor travel between the states, it cannot be said that §14505 was intended to apply to intrastate travel, even if such travel was undertaken on a prearranged basis following an interstate flight. Thus, the taxpayer's intrastate transportation activities are correctly subject to tax.
As for that portion of the taxpayer's transportation activities that involve ferrying passengers from Chicago airports to points outside Illinois, the court noted that §13506(e)(8)(A) of the former Interstate Commerce Commission Act exempted from ICC jurisdiction "passenger transportation by motor vehicle if incidental to aircraft transportation." This provision was interpreted by the ICC to exempt from its jurisdiction ground travel from an airport to a destination within 25 miles of the airport or related commercial zone, even if the travel was between states. Indeed, the court noted, even beyond the 25 mile area, "certain other interstate transportation was regarded as incidental to air travel, including travel between O'Hare and northern Indiana." That Congress adopted verbatim portions of the old Act-including the above provision-in the ICC Termination Act, can only mean that Congress intended "to hold a consistent course relative to local regulation of ground services incidental to interstate air travel." Thus, §14505 must be construed in a manner consistent with Congress' intent not to federally regulate ground transportation incidental to air travel, and there is nothing in the provision to indicate that Congress intended to prohibit the local taxation of ground services incidental to interstate air travel, as had been allowed under the prior Act. Because the taxpayer had not shown that the travel from the Illinois airports to points outside the state were not "incidental to air travel," the court declined to grant the taxpayer in this class the requested relief.
Gross Premiums Tax
Milwaukee Safeguard Insurance Company, et al., v. Selcke, No. 93 L 50663 (Ill. Cir. Ct. 8/9/96). An Illinois circuit court ruled that the state's gross premiums tax violates the Equal Protection Clause of the federal constitution. Illinois subjects foreign insurance companies (i.e., companies not maintaining a principal place of business in the state and other requirements) to a tax of 2% of the insurer's gross premiums for the price of doing business in Illinois. Domestic insurers are not subject to this tax. However, a foreign insurer may escape this tax if a wholly owned subsidiary meets the requirements of a domestic Illinois insurer, even though policies may be transferred from the subsidiary to the foreign parent. Illinois argued that foreign insurers may escape this tax because under the state Insurance Code, a wholly owned subsidiary of a parent foreign corporation are considered a single entity. The court rejected this contention, noting that basic corporation law holds that a subsidiary is a corporation controlled by another corporation by reason of ownership of at least a majority of shares of stock. The court went on to point out that Illinois insurance code does not depart from this principle, even though a wholly owned Illinois subsidiary may transfer business to its foreign parent.
Turning to the Equal Protection Clause, the court concluded that this matter is controlled by Metropolitan Life Ins. Co. v. Ward, 470 U.S. 869 (1985), wherein the Court ruled that while a state may exclude foreign companies from its jurisdiction, once it admits foreign companies the state cannot discriminate between foreign and domestic companies unless the discrimination bears a rational relationship to a legitimate state purpose. The court also cited an earlier U.S. Supreme Court decision, Hanover Fire Ins. Co. v. Harding, 272 U.S. 494 (1926), for the proposition that once a state licenses a corporation to do business in the state, the state may not impose a discriminatory tax on the grounds that the tax is for the continuing privilege of doing business within the jurisdiction. Thus, any tax levied on foreign insurance companies authorized to conduct business in Illinois must have a rational basis besides taxing for the mere privilege of continuing to do business in Illinois. In the instant case, the Illinois statute contravenes the Equal Protection Clause because even if a foreign insurance company meets the statutory requirements, it can never be exempt from the tax, unless it either (1) reincorporates in Illinois, or (2) forms an Illinois subsidiary through which it may conduct its in-state activities. In short, domestic companies are afforded the opportunity to show compliance with the requirements of the state insurance code and thereby avoid the Privilege Tax, while foreign insurers are not. This treatment violates the Equal Protection Clause of the federal constitution, and therefore must fail.