Caterpillar Financial Services Corp. v. Whitley

Procedural entryThis page is a short order in Caterpillar Financial Services Corp. v. Whitley. Read the opinion of the Court — 288 Ill. App. 3d 389
Appellate Court of Illinois·Decided May 19, 1997·No. 3-94-0830·Published

Opinion

                            No. 3-94-0830  

                  IN THE APPELLATE COURT OF ILLINOIS

                            THIRD DISTRICT

                              A.D., 1996

CATERPILLAR FINANCIAL SERVICES   )  Appeal from the Circuit Court

CORPORATION,                     )  of the 10th Judicial Circuit,

                                )  Peoria County, Illinois       

      Plaintiff-Appellant,      )  

                                )

                                )

       v.                       )  No. 92-CH-42

                                )

                                )  

DOUGLAS WHITLEY, as Director     )

of the Illinois Department of    )

Revenue, PATRICK QUINN, as       )  

Treasurer of the State of        )  

Illinois, and the ILLINOIS       )  

DEPARTMENT OF REVENUE,           )  Honorable

                                )  John A. Barra,

      Defendants-Appellees.     )  Judge, Presiding  

JUSTICE HOLDRIDGE delivered the opinion of the court:

    Benjamin Franklin is credited with the saying that in this

world nothing is certain but death and taxes.  However, we are

convinced that he never had to consider the following: are

royalties and interest paid to a domestic parent company by a

foreign subsidiary under the domestic "water's edge" combined

reporting method of apportioning income to be treated the same as

dividends paid between similar entities under the "single entity"

apportionment method.  We have.  

    After a careful review of the record and the relevant case

law, and considering Dr. Franklin's advice that "haste makes

waste," we find that the Illinois "water's edge" apportionment

method does not unconstitutionally discriminate against interest

and royalty payments from foreign subsidiaries of domestic parent

corporations doing business in Illinois, and we affirm the holding

of the trial court.  

    The plaintiff, Caterpillar Financial Services Corporation

(CFSC), a wholly-owned domestic subsidiary of Caterpillar, Inc.,

brought this action in the circuit court of Peoria County against

the Department of Revenue, Douglas Whitley, Director of Revenue,

and Patrick Quinn, Treasurer of the State of Illinois,

(collectively referred to as "the Department") pursuant to "An Act

in relation to the payment and disposition of monies received by

officers and employees of the State of Illinois by virtue of their

office or employment."  30 ILCS 230/1 et seq. (Michie 1994)(Protest

Monies Act).  CFSC sought a refund of Illinois income tax paid

under protest to the Department of Revenue for tax year 1987.    

    The circuit court entered judgment for CFSC as to a portion of

the protested money, and entered judgment in favor of the

Department on the remainder of the fund.  CFSC appealed, and the

Department chose not to appeal that portion of the judgment in

favor of CFSC. The Department maintains, however, that CFSC's

appeal should be dismissed as an impermissible request for an

advisory opinion.  For the reasons discussed below, we affirm the

judgment of the trial court.       

    FACTUAL BACKGROUND

    Caterpillar, Inc. and its 52 domestic and foreign subsidiaries

operate as a unitary business group, engaged in the manufacture of

engines and earth-moving equipment and related marketing, financial

and service functions.  Of these entities, only Caterpillar, Inc.,

CFSC, and 13 other domestic subsidiaries engaged in business in

Illinois, and were thus required to file Illinois corporate income

tax returns.  No foreign subsidiary engaged in business in

Illinois.  

    Caterpillar, Inc. licenses its trademarks and technology to

foreign subsidiaries, granting those subsidiaries the right to

build and market products identical to those designed and

manufactured domestically.  In the licensing agreements, the

foreign subsidiaries are charged a license fee, or royalty, equal

to 5% of the foreign subsidiaries net sales.  Caterpillar, Inc.

also has licensing agreements with its domestic subsidiaries,

however, these domestic subsidiaries are not charged a royalty.  In

addition, Caterpillar also enters into licensing agreements with

unrelated third parties, foreign and domestic, which may or may not

involve payment of a royalty to Caterpillar.        

    Caterpillar, Inc. and some domestic subsidiaries, including

CFSC, loan money to foreign subsidiaries, from which interest

payments are received.  It is undisputed by the parties that the

royalty and interest payments constitute "business income" as that

term is defined by section 1501(1) of the Illinois Income Tax Act

(IITA) (35 ILCS 5/101 et seq.(Michie 1994)).

    ILLINOIS COMBINED WATER'S EDGE METHOD

    Because a state may not constitutionally tax income earned

outside its borders, the income earned by each Illinois member of

the Caterpillar unitary group must be apportioned between Illinois

and other jurisdictions.  Container Corp. of America V. Franchise

Tax Board, 463 U.S. 159 (1983).  Illinois, like many other states,

has adopted the "combined water's edge method" to determine the

portion of unitary business income to attribute to income earned

within its borders.  35 ILCS 5/304(a)(Michie 1994).  Under this

method of reporting and apportionment, the state does not look

beyond the water's edge, i.e. beyond the geographical boundaries of

the United States, in determining what activities are appropriately

considered part of a unitary business.    

    In general terms, the Illinois combined water's edge method

multiplies the combined net income of domestic unitary corporations

by an apportionment percentage calculated using a three factor

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