Summary
In McLean Trucking Co. v. Lindley (1982), 70 Ohio St.2d 106, 24 O.O.3d 187, 435 N.E.2d 414, the taxpayer had not filed amended returns after federal adjustments and the commissioner assessed the federal adjustments along with additional corrections he identified in his audit.
Summary of this case from Gen. Motors Corp. v. LimbachOpinion
No. 81-1423
Decided May 26, 1982.
Taxation — Franchise tax — Statute of limitations — R.C. 5733.11 — Applicability to increase in franchise tax obligation dictated by federal income tax corrections — Computation of sales factor — R.C. 5733.05 — Special Instruction 21 invalid.
APPEAL and CROSS-APPEAL from the Board of Tax Appeals.
McLean Trucking Company, appellee herein, is a common carrier engaged in the business of transporting goods in 33 states, including Ohio, and the District of Columbia. As an integral part of its operations, appellee maintains shipping terminals in 31 states and the District of Columbia, seven of which are located in Ohio.
For the tax years 1973 through 1977, appellee timely filed its corporate franchise tax reports with the Ohio Department of Taxation. During this period, appellee was audited on two separate occasions by the Internal Revenue Service (IRS). The first audit was approved in 1976, and resulted in an increase in federal taxable income which, in turn, dictated an increase in appellee's Ohio franchise tax liability for the years 1973 and 1974. The second audit was approved in 1977 and, again, appellee's federal taxable income was increased, thereby dictating an increase in appellee's Ohio franchise tax liability for 1975 and 1976.
Despite the fact that R.C. 5733.031(C) required appellee to file, subsequent to these federal adjustments, an amended franchise tax report with the commissioner, appellee failed to apprise the Department of Taxation of the IRS corrections and failed to file any amended franchise tax reports.
On January 28, 1977, appellee filed its corporate franchise tax report for the 1977 tax year. During a subsequent state audit, the commissioner's (appellant's) agents discovered the prior — and unreported — federal adjustments relating to appellee's taxable income. Due to appellee's failure to file the amended franchise tax reports in the wake of the federal adjustments, the commissioner considered appellee's reports for the tax years 1973 through 1976 open for review, notwithstanding the three-year limitations period of R.C. 5733.11.
During the course of this state audit, the commissioner learned that appellee was computing its sales factor, pursuant to R.C. 5733.05(B)(2)(c), by equally dividing freight revenues between the state of origin and the state of destination. Appellee's formula, however, failed to allocate any portion of generated freight revenues to states through which appellee's trucks passed or stopped to transfer cargo.
To remedy this unrepresentative allocation, the commissioner, by means of Special Instruction 21, recalculated appellee's sales factor for the tax years 1973 through 1977, by employing a system-wide mileage ratio.
Special Instruction 21 provides:
"Special Instruction 21 Corporation franchise tax — net income and net worth apportionment methods for interstate transportation companies (R.C. 5733.05)
"(Issued January 1, 1977)
"Pursuant to the Tax Commissioner's authority in Sections 5733.05 and 5733.07, Ohio Revised Code, interstate transportation companies shall use the following in computing the net income and net worth apportionment formulas on the Ohio Corporation Franchise Tax Report.
"I. Net Income Basis
"A. Property Factor
"The original cost of all fixed properties (real and tangible personal property) such as buildings and land, ship and terminal equipment and trucks and cars used locally or any other tangible property will be assigned to Ohio if the properties are located in Ohio.
"The original cost of all movable equipment used in interstate transportation will be assigned to Ohio on the basis of total miles travelled in Ohio as compared to total miles everywhere.
"Fixed and movable property will then be combined and the value at the beginning and the end of the taxable year averaged to arrive at the total property factor, Ohio property over property everywhere.
"Property rented by the corporation shall be valued at eight times the net annual rental rate. Net annual rental rate means the annual rental rate paid by the corporation less any annual rate received by the corporation from sub-rentals.
"B. Payroll Factor
"Compensation of employees assigned to fixed locations within Ohio shall be included in the Ohio payroll factor. Compensation of employees operating interstate transportation equipment will be assigned to Ohio on the basis of total miles travelled in Ohio as compared to total miles travelled everywhere. The payroll of permanent and transient employees will then be combined to arrive at the total payroll factor, Ohio payroll over payroll everywhere.
"C. Sales Factor
"Revenues from transportation will be assigned to Ohio in the proportion that the total miles travelled within Ohio bear to the total miles travelled everywhere.
"II. Net Worth Basis
"A. Property Factor
"For purposes of the property factor on the net worth basis, movable equipment will be assigned to Ohio for balance sheet purposes on the basis of total miles travelled in Ohio as compared to total miles everywhere. Fixed property shall be assigned to Ohio for balance sheet purposes if the property is located in Ohio.
"B. Business Done Factor
"For purposes of the business done factor on the net worth basis, revenues from transportation will be assigned to Ohio in the proportion that the total miles travelled within Ohio bear to the total miles travelled everywhere."
The effect of the commissioner's re-opening of appellee's prior franchise tax reports resulted in an additional tax deficiency of $208,619.67, whereas the federal adjustments alone, without re-opening the prior franchise tax reports, resulted in a tax deficiency of merely $1,270.50. Including tax year 1977, appellee, on November 1, 1979, was presented, by the commissioner, with a $336,027.31 tax assessment, including the statutory penalty.
In appealing the commissioner's determination to the Board of Tax Appeals (the board), appellee essentially contended that (1) the assessment issued, insofar as it pertains to increases in its 1973 through 1976 franchise tax obligation unrelated to the corrections made by the IRS, is barred by R.C. 5733.11; (2) the commissioner's method of recomputing the sales factor for tax years 1973 through 1976 constituted a retroactive application of Special Instruction 21, which was issued January 1, 1977; and (3) Special Instruction 21 was an invalid apportionment mechanism which incorrectly reflected appellee's business activity in Ohio.
On September 9, 1981, the board issued its order and ruled that the limitations period of R.C. 5733.11: (1) was an absolute bar insofar as the commissioner's assessment pertained to increases in appellee's 1973 through 1976 franchise tax obligation unrelated to the corrections made by the IRS; and (2) does not preclude the commissioner's assessment insofar as it pertains to increases in appellee's 1973 through 1976 franchise tax obligation related to the corrections made by the IRS. The board also viewed the commissioner's employment of Special Instruction 21 as an acceptable method of computing a common carrier's sales factor pursuant to R.C. 5733.05.
The commissioner has prosecuted an appeal to this court and contends, in essence, that the appellee's failure to notify him of the IRS alterations by filing amended franchise tax reports enables him to re-open appellee's prior franchise tax reports and recalculate appellee's corporate franchise tax liability.
Appellee, in turn, has filed a cross-appeal challenging the commissioner's computation of the R.C. 5733.05 sales factor for tax year 1977, pursuant to Special Instruction 21.
The cause is now before this court pursuant to an appeal and cross-appeal as of right.
Messrs. Porter, Wright, Morris Arthur, Mr. Roger F. Day and Mr. Leonard A. Carlson, for appellee and cross-appellant.
Mr. William J. Brown, attorney general, and Mr. Charles M. Steines, for appellant and cross-appellee.
The two critical issues in this case concern the three-year limitations period for assessments made by the commissioner, pursuant to R.C. 5733.11, and the commissioner's calculation of appellee's sales factor, pursuant to R.C. 5733.05 and Special Instruction 21. We shall consider these issues seriatim.
I.
Statute of Limitations: Tax Years 1973-1976.
R.C. 5733.11, which sets forth the three-year limitation for assessments, provides, in pertinent part:
"When any corporation required to file a report by this chapter fails to file such report within the time prescribed, files an incorrect report, or fails to remit the full amount of the tax due for the period covered by the report, the tax commissioner may make an assessment against such corporation for the period for which such report or tax is due, based upon any information in his possession. The commissioner shall give the corporation against whom such assessment is made written notice of such assessment by personal service or certified mail.
" No such assessment shall be made or issued against a taxpayer more than three years after the final date as of which such report subject to assessment was required to be filed, provided that there shall be no bar or limit to an assessment against a taxpayer that failed to file the report subject to assessment as required by this chapter." (Emphasis added.)
In other words, R.C. 5733.11 bars the commissioner from issuing an assessment against the taxpayer more than three years after the final date as of which the report subject to assessment was required to be filed with the commissioner. By the same reasoning, however, R.C. 5733.11 eliminates any bar to an assessment against the taxpayer that fails to file the report subject to assessment pursuant to R.C. Chapter 5733.
The fundamental question posed by appellee is whether the assessment issued insofar as it pertains to increases in its 1973 through 1976 franchise tax obligation unrelated to the corrections made by the IRS is barred by R.C. 5733.11. For the reasons that follow, we conclude that the limitations period of R.C. 5733.11: (1) is an absolute bar insofar as the instant assessment pertains to increases in appellee's 1973 through 1976 franchise tax obligation unrelated to the corrections made as a result of the IRS audit; and (2) does not preclude the instant assessment insofar as it pertains to increases in appellee's 1973 through 1976 franchise tax obligation related to the corrections made as a result of the IRS audit.
Pursuant to R.C. 5733.031(C), appellee, subsequent to the audit and assessment of the IRS, was statutorily obligated to notify the commissioner of the aforementioned federal alterations by filing an amended franchise tax report within 120 days after the federal alterations became final. As the record reveals, appellee failed to file an amended franchise tax report with the commissioner for the tax years 1973 through 1976.
"(C) If the taxable income, any item of income or deduction, or the income tax liability, reported in a corporation's federal income tax return that is used to determine the corporation's tax under this chapter is altered by amendment of such return or as a result of any other recomputation or redetermination of federal taxable income or loss, by the corporation or the internal revenue service, and such alteration reflects a change or settlement that affects such corporation's tax liability under this chapter, such corporation shall notify the tax commissioner of such alteration.
"Such notification shall be in the form of an amended return or such other form as the tax commissioner requires, and shall be filed with the tax commissioner not later than one hundred twenty days after such alteration has been agreed to or finally determined for federal income tax purposes or any federal income tax deficiency or refund, or the abatement or credit resulting therefrom, has been assessed or paid, whichever occurs first."
Thus, our inquiry narrows to the question of whether the failure to file an amended franchise tax report constitutes a failure to file a report, for R.C. 5733.11 purposes, thus rendering inapplicable the statutory time limitation to which assessments are restricted.
After a careful review of the precise language of R.C. 5733.11, we conclude that the "reports" anticipated by this section include annual reports and amended reports. In this cause, however, the "reports" which the taxpayer "fail[ed] to file * * * [which are] subject to assessment," are the amended reports, not the annual franchise tax returns. Therefore, when, after the federal audit and assessment, appellee failed to file the amended franchise tax reports with the commissioner, appellee was in violation of R.C. 5733.11, thus suspending the three-year ban to any state assessment related to the federal adjustments.
We categorically reject, as impractical, appellant's contention that, if a taxpayer fails to file an amended franchise tax report, there is no bar or no time limit to the assessment which may be issued. The wholesale re-opening of a taxpayer's reports on such an unrestricted basis would impede the attainment of the goals of certainty and finality in tax planning and tax collection — for both the taxpayer and the Tax Commissioner.
In light of the foregoing analysis, therefore, we conclude that only the amended reports for the tax years 1973 through 1976 are subject to assessment. The taxpayer's annual reports, which have already been filed and are subject to the three-year limitation of R.C. 5733.11, may not now be re-opened, except for the limited purpose of rendering an assessment with respect to the federal corrections that would have been reflected if the amended reports had been timely filed. Thus, we affirm that part of the board's order which: (1) permitted the $1,270.50 deficiency assessment and (2) disallowed the $208,619.67 deficiency assessment.
II.
Computation of Appellee's Sales Factor for Tax Year 1977.
In its cross-appeal, appellee has challenged the commissioner's computation of the sales factor, pursuant to R.C. 5733.05, for the tax year 1977.
R.C. 5733.05(B) sets forth an apportionment formula for determining the amount of net income which a corporation engaged in interstate commerce shall allocate to Ohio, based on three factors: property, payroll and sales.
Pursuant to R.C. 5733.05, appellee is a net income taxpayer.
R.C. 5733.05(B)(2)(c) provides in pertinent part:
"* * * [A] fraction the numerator of which is the value of business done, measured by sales of tangible personal property in this state by the corporation during the taxable year, and the denominator of which is the total value of its business done, measured by sales of tangible personal property by the corporation everywhere during such year. * * *
"* * *
"Sales, other than sales of tangible personal property, are in this state if either:
"(i) The income-producing activity is performed in this state;
"(ii) The income-producing activity is performed both within and without this state and a greater proportion of the income-producing activity is performed within this state than in any other state, based on costs of performance. * * *"
Additionally, R.C. 5733.05(B)(2)(d), an exception to R.C. 5733.05(B)(2)(a), (b) and (c), provides that if the foregoing three-factor formula does not fairly represent the extent of the taxpayer's business activity in Ohio, the commissioner may require a separate accounting, the exclusion of one or more factors, or the inclusion of one or more factors in order to represent the taxpayers allocated or apportioned base in this state.
Specifically, R.C. 5733.05(B)(2)(d) provides:
"If the allocation and apportionment provisions of division (B) of this section do not fairly represent the extent of the taxpayer's business activity in this state, the taxpayer may request, * * * or the tax commissioner may require, in respect to all or any part of the taxpayer's allocated or apportioned base, if reasonable, any one or more of the following:
"(i) Separate accounting;
"(ii) The exclusion of any one or more of the factors;
"(iii) The inclusion of one or more additional factors which will fairly represent the taxpayer's allocated or apportioned base in this state.
" An alternative method will be effective only with approval by the tax commissioner." (Emphasis added.)
Resolution of appellee's challenge to the commissioner's computation of its sales factor necessarily entails deciding: (1) whether the commissioner, in apportioning appellee's revenues through the system-wide mileage ratio of Special Instruction 21, properly proceeded under R.C. 5733.05(B)(2)(d); and (2) whether Special Instruction 21 constitutes an administrative rule which was promulgated in accordance with R.C. 119.03 and 5703.14.
During the course of appellee's audit, the commissioner discovered that appellee was equally allocating income for freight transportation between the state in which the shipment originated and the state in which the shipment terminated. This allocation method failed to apportion income to those states through which appellee transported freight. To remedy this unrepresentative allocation, the commissioner, by means of Special Instruction 21, reapportioned appellee's revenues by employing a sales factor based on a system-wide mileage ratio.
After having considered and evaluated the arguments advanced by all the litigants at bar, we conclude, for the reasons that follow, that: (1) the commissioner, in apportioning appellee's revenues through the system-wide mileage ratio of Special Instruction 21, did not properly proceed under, or in compliance with, R.C. 5733.05(B)(2)(d); and (2) Special Instruction 21 is an administrative rule which was not promulgated in accordance with R.C. 119.03 and 5703.14 and is, therefore, invalid.
Initially, it is imperative to note that R.C. 5733.05 (B)(2)(d) furnishes no authority for the commissioner's apportionment of appellee's sales factor pursuant to Special Instruction 21. More precisely, R.C. 5733.05(B)(2)(d), by its express language, contemplates a customized, individualized allocation, tailored to each taxpayer on a case-by-case basis, when the three-factor formula of R.C. 5733.05(B)(2)(a), (b) and (c) does not fairly represent the extent of the taxpayer's business activity in Ohio. Clearly, Special Instruction 21 which, by its own terms, applies to all interstate carriers in a general, across-the-board, all-encompassing manner, does not reflect the particularized apportionment approach which, in our view, the General Assembly intended the Tax Commissioner to employ in calculating the franchise tax liability for corporations not embraced by R.C. 5733.05(B)(2)(a), (b) or (c). As such, we find that Special Instruction 21 was not authorized by R.C. 5733.05(B)(2)(d).
Furthermore, we find that Special Instruction 21 is the functional equivalent of an R.C. 119.01(C) rule, the terms of which could only have been properly issued as a rule.
More specifically, pursuant to R.C. 119.01(C):
"`Rule' means any rule, regulation, or standard, having a general and uniform operation, adopted, promulgated, and enforced by any agency under the authority of the laws governing such agency, but it does not include regulations concerning internal management of the agency which do not affect private rights."
Applying this definition to Special Instruction 21, it is immediately apparent that the subject-matter of Special Instruction 21 is, as a practical matter, the subject-matter of a rule because Special Instruction 21: (1) articulates a general and uniform apportionment method for all interstate transportation companies, and (2) is being enforced under the authority of the laws governing the department of taxation.
The Department of Taxation is an "agency", as that term is defined in R.C. 119.01(A), and was an "agency" on January 1, 1977 (see Am. Sub. H.B. No. 920, effective October 11, 1976 [136 Ohio Laws 3182, 3183]).
Since the terms of Special Instruction 21 could only have been promulgated as a rule, the focus of our inquiry becomes whether Special Instruction 21 was promulgated in compliance with R.C. 5703.14 and 119.03.
R.C. 5703.14 provided that;
These provisions reflect the version of R.C. 5703.14 which was in effect on January 1, 1977 — the issue date of Special Instruction 21. (See Am. Sub. H.B. No. 920, at 3222.) R.C. 5703.14 has been subsequently amended to impose additional requirements upon the commissioner in the promulgation of rules.
"No rule * * * of the department of taxation adopted by the tax commissioner shall be effective until the tenth day after it is * * * [filed] in the office of the secretary of state.
"* * *
"Applications for review of any rule adopted and promulgated by the commissioner may be filed * * * [by certain parties] after the rule is filed in the office of the Secretary of State. * * *"
R.C. 119.03 mandated 30 days public notice of an agency's intention to promulgate a rule and further required that a proposed rule be filed with: (1) the Director of the Legislative Reference Bureau, (2) the Clerk of the Senate, and (3) the Legislative Clerk of the House of Representatives.
These provisions reflect the version of R.C. 119.03 which was in effect on January 1, 1977. (See Am. Sub. H.B. No. 317, effective September 30, 1976 [136 Ohio Laws 2399, 2401].)
In issuing Special Instruction 21 on January 1, 1977, the commissioner did not file it with the Secretary of State, the Director of the Legislative Reference Bureau, the Clerk of the Senate or the Legislative Clerk of the House of Representatives. The commissioner also failed to give any public notice of Special Instruction 21's proposed issuance. As such, the failure of the commissioner to promulgate Special Instruction 21 in accordance with the dictates of R.C. 119.02 renders Special Instruction 21 invalid. See, also, Bd. of Trustees v. Dept. of Admin. Services (1981), 68 Ohio St.2d 149 (rules adopted by an agency in violation of the required statutory procedures are invalid and of no effect).
R.C. 119.02 provides:
"Every agency authorized by law to adopt, amend, or rescind rules shall comply with the procedure prescribed in sections 119.01 to 119.13, inclusive, of the Revised Code, for the adoption, amendment, or rescission of rules. Unless otherwise specifically provided by law, the failure of any agency to comply with such procedure shall invalidate any rule or amendment adopted, or the recission of any rule."
Thus, we reverse that part of the board's decision upholding the commissioner's employment of Special Instruction 21 to calculate appellee's franchise tax liability.
For all of the foregoing reasons, the decision of the board is affirmed in part and reversed in part. The cause is remanded for further proceedings not inconsistent with this opinion.
Decision affirmed in part and reversed in part, and cause remanded.
CELEBREZZE, C.J., W. BROWN, SWEENEY, LOCHER, HOLMES, C. BROWN and KRUPANSKY, JJ., concur.