1. The state Supreme Court approved a ruling striking out
evidence offered to prove a tax unconstitutional, but adjudged
that, even if the evidence were deemed competent, the tax was
valid.
Held that
Page 283 U. S. 124
the case may be viewed as though the evidence had been received
and held to have no bearing on the validity of the taxing statute.
P.
283 U. S.
126.
2. The method of allocating, for taxation, to a state that part
of the net income of a foreign corporation which bears the same
ratio to its entire net income as the value of its tangible
property within that state bears to the value of all its tangible
property works an unconstitutional result if, in the particular
case, the part of the income thus attributed to the state is out of
all appropriate proportion to the business there transacted by the
corporation. Pp.
283 U. S. 129,
283 U. S.
135.
So
held in the case of a North Carolina tax on income
of a New York corporation which bought leather, manufactured it in
North Carolina, and sold its products at wholesale and retail in
New York.
Underwood Typewriter Co. v. Chamberlin,
254 U. S. 113;
Bass, Ratclilf & Gretton v. Tax Commission,
266 U. S. 271, and
National Leather Co. v. Massachusetts, 277 U.
S. 413, distinguished.
3. The fact that a corporate enterprise is a unitary one, in the
sense that the ultimate gain is derived from the entire business,
does not mean that, for the purpose of taxation, the activities
which are conducted in different jurisdictions are to be regarded
as "component parts of a single unit" so that the entire net income
may be taxed in one state regardless of the extent to which it may
be derived from the conduct of the enterprise in another state. P.
283 U. S.
133.
4. When there are different taxing jurisdictions, each competent
to lay a tax with respect to what lies within, and is done within,
its own borders, and the question is necessarily one of
apportionment, evidence may always be received which tends to show
that a state has applied a method, which, albeit fair on its face,
operates so as to reach profits which are in no sense attributable
to transactions within its jurisdiction. P.
283 U. S.
134.
199 N.C. 42, 153 S.E. 850, reversed.
Appeal from a judgment sustaining the dismissal of proceedings
for readjustment of a state income tax assessment.
Page 283 U. S. 125
MR. CHIEF JUSTICE HUGHES delivered the opinion of the Court.
The appellant, Hans Rees' Sons, Inc., a corporation organized
under the laws of New York, began this action by an application to
the Commissioner of Revenue of the State of North Carolina for the
readjustment of the income tax assessed against the appellant by
that state. The assessment was for the years 1923, 1924, 1925, and
1926, in accordance with the applicable state laws,
* and the
controversy related to the proper allocation of income to the State
of North Carolina. The commissioner of revenue made his findings of
fact and conclusions of law, the appellant's exceptions were
overruled, and the prayer for revision of the taxes was disallowed.
Appeal, waiving a jury, was taken to the superior court of Buncombe
County, North Carolina. On the trial in that court, evidence was
introduced by the appellant with respect to the course of business
and the amount and sources of income for the years in question. The
appellant admitted that,
"(a) in assessing the tax, the Commissioner of Revenue followed
the statutory method; . . . (b) that the valuation of the real
estate and tangible property of the taxpayer 'both within and
without the state' is correct; (c) that the total net income used
as a basis for the calculation of the tax is correct; (d) that the
allocation of the net income for purposes of taxation was in full
accord with the statute."
The contention of the appellant was that the income tax statute
as applied to the appellant, upon the facts disclosed, was
arbitrary
Page 283 U. S. 126
and unreasonable, and was repugnant to the commerce clause and
to § 1 of the Fourteenth Amendment of the Federal Constitution. The
superior court struck out the testimony offered by the appellant as
being immaterial, and held that the statute, as applied, did not
violate constitutional rights. The judgment dismissing the action
was affirmed by the supreme court of the state. 199 N.C. 42, 153
S.E. 850, 853. The case comes here on appeal.
As to the portions of the taxes for the years in question, which
had been paid by the appellant voluntarily and as to which recovery
was denied upon that ground, no question is raised here.
The supreme court of the state sustained the ruling of the trial
court in striking out the evidence offered by the appellant, but
held that, if the evidence were deemed to be competent, it would
not change the result. The case may therefore be viewed as though
the evidence had been received and held to have no bearing on the
validity of the statute.
Fairmont Creamery Co. v.
Minnesota, 274 U. S. 1,
274 U. S. 5. The
evidence was thus summarized by the state court:
"This evidence tended to show that the petitioner (the appellant
here) was incorporated in the State of New York in 1901 and is
engaged in the business of tanning, manufacturing, and selling
belting and other heavy leathers. Many years prior to 1923, it
located a manufacturing plant at Asheville, North Carolina, and,
after this plant was in full operation, dismantled and abandoned
all plants which it had heretofore operated in different states of
the Union. The business is conducted upon both wholesale and retail
plans. The wholesale part of the business consists in selling
certain portions of the hide to shoe manufacturers and others in
carload lots. The retail part of the business consists in cutting
the hide into innumerable pieces, finishing it in various ways and
manners,
Page 283 U. S. 127
and selling it in less than carload lots. In order to facilitate
sales a warehouse is maintained in New York from which shipments
are made of stock on hand to various customers. The tannery at
Asheville is used as the manufacturing plant and a supply house,
and, when the quantity or quality of merchandise required by a
customer is not on hand in the New York warehouse, a requisition is
sent to the plant at Asheville to ship to the New York warehouse or
direct to the customer. The sales office is located in New York,
and the salesmen report to that office. Sales are made throughout
this country and in Canada and Continental Europe. Some sales are
also made in North Carolina. Certain finishing work is done in New
York. The evidence further tended to show that"
"between forty and fifty percent of the output of the plant in
Asheville is shipped from the Asheville tannery to New York. The
other sixty percent is shipped direct on orders from New York. . .
. Shipment is made direct from Asheville to the customer."
"The petitioner also offered evidence to the effect that the
income from the business was derived from three sources, to-wit:
(1) buying profit; (2) manufacturing profit; (3) selling profit. It
contends that buying profit resulted from unusual skill and
efficiency in taking advantage of fluctuations of the hide market;
that manufacturing profit was based upon the difference between the
cost of tanning done by contract and the actual cost thereof when
done by the petitioner at its own plant in Asheville, and that
selling profit resulted from the method of cutting the leather into
small parts so as to meet the needs of a given customer."
"Without burdening this opinion with detailed compilations set
out in the record, the evidence offered by the petitioner tends to
show that, for the years 1923, 1924, 1925, and 1926, the average
income having its source in the manufacturing and tanning
operations within the State of North Carolina was 17 percent "
Page 283 U. S. 128
According to the assessments in question, as revised by the
commissioner of revenue and sustained, there was allocated to the
State of North Carolina, pursuant to the prescribed statutory
method, for the year 1923, 83+ percent of the appellant's income;
for 1924, 85+ percent; for 1925, 66+ percent, and for 1926, 85+
percent
The applicable statutory provisions, as set forth by the state
court, are as follows:
"Every corporation organized under the laws of this state shall
pay annually an income tax, equivalent to four percent of the
entire net income as herein defined, received by such corporation
during the income year, and every foreign corporation doing
business in this state shall pay annually an income tax equivalent
to four percent of a proportion of its entire income to be
determined according to the following rules:"
"(a) In case of a company other than companies mentioned in the
next succeeding section, deriving profits principally from the
ownership, sale or rental of real estate or from the manufacture,
purchase, sale of, trading in, or use of tangible property, such
proportion of its entire net income as the fair cash value of its
real estate and tangible personal property in this state on the
date of the close of the fiscal year of such company in the income
year is to the fair cash value of its entire real estate and
tangible personal property then owned by it, with no deductions on
account of encumbrances thereon."
"(b) In case of a corporation deriving profits principally from
the holding or sale of intangible property, such proportion as its
gross receipts in this state for the year ended on the date of the
close of its fiscal year next preceding is to its gross receipts
for such year within and without the state."
"(c) The words 'tangible personal property' shall be taken to
mean corporeal personal property, such as machinery,
Page 283 U. S. 129
tools, implements, goods, wares, and merchandise, and shall not
be taken to mean money deposits in bank, shares of stock, bonds,
notes, credits, or evidence of an interest in property and
evidences of debt."
Relying upon the decisions of this Court with respect to
statutes of a similar sort enacted by other states, the supreme
court of the state held that the statute of North Carolina was not
invalid upon its face.
Underwood Typewriter Co. v.
Chamberlain, 254 U. S. 113,
254 U. S.
120-121;
Bass, Ratcliff & Gretton, Ltd. v. State
Tax Commission, 266 U. S. 271,
266 U. S.
280-283;
National Leather Co. v. Massachusetts,
277 U. S. 413,
277 U. S. 423.
In
Underwood Typewriter Co. v. Chamberlain, supra, a
statute of Connecticut imposed upon foreign corporations doing
business partly within and partly without the state, an annual tax
of two percent upon the net income earned during the preceding year
on business carried on within the state, ascertained by taking such
proportion of the whole net income on which the corporation was
required to pay a tax to the United States as the value of its real
and tangible personal property within the state bore to the value
of all its real and tangible personal property. All the
manufacturing by the corporation was done in Connecticut, but the
greater part of its sales were made from branch offices in other
states. It was contended that the tax was an unconstitutional
burden upon interstate commerce, and that it violated the
Fourteenth Amendment in that it imposed a tax on income arising
from business conducted without the state. In support of the latter
objection, the corporation showed that, while 47 percent of its
real estate and tangible personal property was located in
Connecticut, almost all its net profits were received in other
states. This Court said:
"But this showing wholly fails to sustain the objection. The
profits of the corporation were largely earned by a series of
transactions
Page 283 U. S. 130
beginning with manufacture in Connecticut and ending with sale
in other states. In this, it was typical of a large part of the
manufacturing business conducted in the state. The legislature, in
attempting to put upon this business its fair share of the burden
of taxation, was faced with the impossibility of allocating
specifically the profits earned by the processes conducted within
its borders. It therefore adopted a method of apportionment which,
for all that appears in this record, reached, and was meant to
reach, only the profits earned within the state. 'The plaintiff's
argument on this branch of the case,' as stated by the supreme
court of errors,"
"carries the burden of showing that 47 percent of its net income
is not reasonably attributable, for purposes of taxation, to the
manufacture of products from the sale of which 80 percent of its
gross earnings was derived after paying manufacturing costs."
The corporation has not even attempted to show this, and, for
aught that appears, the percentage of net profits earned in
Connecticut may have been much larger than 47 percent. There is
consequently nothing in this record to show that the method of
apportionment adopted by the state was inherently arbitrary, or
that its application to this corporation produced an unreasonable
result.
In this view, the validity of the Connecticut statute was
sustained.
In the case of
Bass, Ratcliff & Gretton, Ltd. v. State
Tax Commission, supra, the State of New York imposed an annual
franchise tax at the rate of three percent upon the net income of
the corporation. The Court, describing the statute, said that,
"if the entire business of the corporation is not transacted
within the state, the tax is to be based upon the portion of such
ascertained net income determined by the proportion which the
aggregate value of specified classes of the assets of the
corporation within the state bears to the aggregate value of all
such classes of
Page 283 U. S. 131
assets wherever located."
The corporation in that case was British, engaged in brewing and
selling Bass' ale. Its brewing was done, and a large part of its
sales were made, in England, but it had imported a portion of its
product into the United States which it sold in branch offices
located in New York and Chicago. The Court regarded the question of
the constitutional validity of the New York tax as controlled in
its essential aspect by the decision in
Underwood Typewriter
Co. v. Chamberlain, supra. And, referring to the facts of that
case, the Court said:
"So, in the present case, we are of opinion that, as the company
carried on the unitary business of manufacturing and selling ale,
in which its profits were earned by a series of transactions
beginning with the manufacture in England and ending in sales in
New York and other places -- the process of manufacturing resulting
in no profits until it ends in sales -- the state was justified in
attributing to New York a just proportion of the profits earned by
the Company from such unitary business. . . . Nor do we find that
the method of apportioning the net income on the basis of the ratio
of the segregated assets located in New York and elsewhere was
inherently arbitrary, or a mere effort to reach profits earned
elsewhere under the guise of legitimate taxation. . . . It is not
shown in the present case, any more than in the
Underwood
case, that this application of the statutory method of
apportionment has produced an unreasonable result."
In the instant case, the state court, having considered these
decisions, held that the statute of North Carolina was valid upon
its face, and sought to justify its view that the evidence offered
by the appellant was without effect, upon the following
grounds:
"The fallacy of this conclusion [that is, the appellant's
contention that the application of the statute had been shown to be
unreasonable and arbitrary, and hence
Page 283 U. S. 132
repugnant to the Federal Constitution] lies in the fact that the
petitioner undertakes to split into independent sources income
which the record discloses was created and produced by a single
business enterprise. Hides were bought for the purpose of being
tanned and manufactured into leather at Asheville, North Carolina,
and this product was to be shipped from the plant and sold and
distributed from New York to the customer. The petitioner was not
exclusively a hide dealer or a mere tanner or a leather salesman.
It was a manufacturer and seller of leather goods, involving the
purchase of raw material and the working up of that raw material
into acceptable commercial forms, for the ultimate purpose of
selling the finished product for a profit. Therefore, the buying,
manufacturing, and selling were component parts of a single unit.
The property in North Carolina is the hub from which the spokes of
the entire wheel radiate to the outer rim."
And, in its final conclusion, the state court said that, if it
were conceded that the evidence offered by the appellant was
competent, still, as it showed that the appellant "was conducting a
unitary business as contemplated and defined by the courts of final
jurisdiction," it was
"not permissible to lop off certain elements of the business
constituting a single unit, in order to place the income beyond the
taxing jurisdiction of this state."
We are unable to agree with this view. Evidence which was found
to be lacking in the
Underwood and
Bass cases is
present here. These decisions are not authority for the conclusion
that, where a corporation manufactures in one state and sells in
another, the net profits of the entire transaction, as a unitary
enterprise, may be attributed, regardless of evidence, to either
state. In the
Underwood case, it was not decided that the
entire net profits of the total business were to be allocated to
Connecticut because that was the place of manufacture, or, in the
Bass case,
Page 283 U. S. 133
that the entire net profits were to be allocated to New York
because that was the place where sales were made. In both
instances, a method of apportionment was involved which, as was
said in the
Underwood case, "for all that appears in this
record, reached, and was meant to reach, only the profits earned
within the state." The difficulty with the evidence offered in the
Underwood case was that it failed to establish that the
amount of net income with which the corporation was charged in
Connecticut under the method adopted was not reasonably
attributable to the processes conducted within the borders of that
state, and, in the
Bass case, the Court found a similar
defect in proof with respect to the transactions in New York.
Undoubtedly the enterprise of a corporation which manufactures
and sells its manufactured product is ordinarily a unitary
business, and all the factors in that enterprise are essential to
the realization of profits. The difficulty of making an exact
apportionment is apparent, and hence, when the state has adopted a
method not intrinsically arbitrary, it will be sustained until
proof is offered of an unreasonable and arbitrary application in
particular cases. But the fact that the corporate enterprise is a
unitary one, in the sense that the ultimate gain is derived from
the entire business, does not mean that, for the purpose of
taxation, the activities which are conducted in different
jurisdictions are to be regarded as "component parts of a single
unit," so that the entire net income may be taxed in one state
regardless of the extent to which it may be derived from the
conduct of the enterprise in another state. As was said in the
Bass case with regard to "the unitary business of
manufacturing and selling ale" which began with manufacturing in
England and ended in sales in New York, that state "was justified
in attributing to New York a just proportion of the profits earned
by the company from such unitary business."
Page 283 U. S. 134
And the principle that was recognized in
National Leather
Co. v. Massachusetts, supra, was that a tax could lawfully be
imposed upon a foreign corporation with respect to "the
proportionate part of its total net income which is attributable to
the business carried on within the state." When, as in this case,
there are different taxing jurisdictions, each competent to lay a
tax with respect to what lies within, and is done within, its own
borders, and the question is necessarily one of apportionment,
evidence may always be received which tends to show that a state
has applied a method, which, albeit fair on its face, operates so
as to reach profits which are in no just sense attributable to
transactions within its jurisdiction.
Nor can the evidence be put aside in the view that it merely
discloses such negligible criticisms in allocation of income as are
inseparable from the practical administration of a taxing system in
which apportionment with mathematical exactness is impossible. The
evidence in this instance, as the state court puts it,
"tends to show that, for the years 1923, 1924, 1925, and 1926,
the average income having its source in the manufacturing and
tanning operations within the North Carolina was seventeen
percent,"
while, under the assessments in question, there was allocated to
the State of North Carolina approximately 80 percent of the
appellant's income.
An analysis has been submitted by the appellant for the purpose
of showing that the percentage of its income attributable to North
Carolina for the years in question did not, in any event, exceed
21.7 percent. As pointed out by the state court, the appellant's
evidence was to the effect that the income from its business was
derived from three sources, buying profit, manufacturing profit,
and selling profit. The appellant states that its sales were both
wholesale and retail; that the profits from the wholesale business
were in part attributable to the manufacturing in Asheville and in
part to the selling in New York,
Page 283 U. S. 135
but that the appellant's accountants made no attempt to separate
this, and that the entire wholesale profit was credited to
manufacturing and allocated to North Carolina. Similarly, it is
said that no attempt was made to separate profits from
manufacturing in New York from profits derived from manufacturing
in Asheville, and that all manufacturing profits were allocated to
North Carolina. It is insisted that, in the retail part of the
business, the leather is cut into small pieces and finished in
particular ways and supplied in small lots to meet the particular
needs of individual customers, and that this part of the business
is essential to the retail merchandising business conducted from
the New York office. The so-called "buying profit" is said to
result from the skill with which hides are bought, and the
contention is that these buying operations were not conducted in
North Carolina. If, as to the last, it be said that the buying of
raw material for the manufacturing plant should be regarded as
incident to the manufacturing business, and as reflected in the
value at wholesale of the manufactured product as turned out at the
factory, still it is apparent that the amount of the asserted
buying profit is not enough to affect the result so far as the
constitutional question is concerned.
For the present purpose, in determining the validity of the
statutory method as applied to the appellant, it is not necessary
to review the evidence in detail, or to determine as a matter of
fact the precise part of the income which should be regarded as
attributable to the business conducted in North Carolina. It is
sufficient to say that, in any aspect of the evidence, and upon the
assumption made by the state court with respect to the facts shown,
the statutory method, as applied to the appellant's business for
the years in question operated unreasonably and arbitrarily, in
attributing to North Carolina a percentage of income out of all
appropriate proportion to the business transacted by the appellant
in that state. In this view,
Page 283 U. S. 136
the taxes as laid were beyond the state's authority.
Shaffer
v. Carter, 252 U. S. 37,
252 U. S. 52-53,
252 U. S.
57.
For this reason, the judgment must be reversed, and the cause
remanded for further proceedings not inconsistent with this
opinion.
It is so ordered.
* Laws of 1923, c. 4, § 201; 1925, c. 101, § 201; 1927, c. 80, §
311.