Moorman Manufacturing Co. v. Bair

437 U.S. 267, 98 S. Ct. 2340, 57 L. Ed. 2d 197, 1978 U.S. LEXIS 111

Opinions

Mr. Justice Stevens

delivered the opinion of the Court.

The question in this case is whether the single-factor sales formula employed by Iowa to apportion the income of an interstate business for income tax purposes is prohibited by the Federal Constitution.

I

Appellant, Moorman Manufacturing Co., is an Illinois corporation engaged in the manufacture and sale of animal feeds. Although the products it sells to Iowa customers are manufactured in Illinois, appellant has over 500 salesmen in Iowa and it owns six warehouses in the State from which deliveries are made to Iowa customers. Iowa sales account for about 20% of appellant's total sales.

Corporations, both foreign and domestic, doing business in Iowa are subject to the State’s income tax. The taxable income for federal income tax purposes, with certain adjustments, is treated as the corporation’s “net income” under the Iowa statute. If a corporation’s business is not conducted entirely within Iowa, the statute imposes a tax only on the portion of its income “reasonably attributable” to the business within the State.

There are essentially two steps in computing the share of a corporation’s income “reasonably attributable” to Iowa. First, certain income, “the geographical source of which is easily identifiable,” is attributed entirely to a particular State.¹ Second, if the remaining income is derived from the manufacture or sale of tangible personal property, “the part thereof attributable to business within the state shall be in that proportion which the gross sales made within the state bear to the total gross sales.” ² This is the single-factor formula that appellant challenges in this case.

If the taxpayer believes that application of this formula subjects it to taxation on a greater portion of its net income than is “reasonably attributable” to business within the State, it may file a statement of objections and submit an alternative method of apportionment. If the evidence submitted by the taxpayer persuades the Director of Revenue that the statute is “inapplicable and inequitable” as applied to it, he may recalculate the corporation’s taxable income.

During the fiscal years 1949 through 1960, the State Tax Commission allowed appellant to compute its Iowa income on the basis of a formula consisting of three, equally weighted factors — property, payroll, and sales — rather than the formula prescribed by statute.³ For the fiscal years 1961 through 1964, appellant complied with a directive of the State Tax Commission to compute its income in accordance with the statutory formula. Since 1965, however, appellant has resorted to the three-factor formula without the consent of the commission.

In 1974, the Iowa Director of Revenue revised appellant’s tax assessment for the fiscal years 1968 through 1972. This assessment was based on the statutory formula, which produced a higher percentage of taxable income than appellant, using the three-factor formula, had reported on its return in each of the disputed years.⁴ The higher percentages, of course, produced a correspondingly greater tax obligation for those years.⁵

After the Tax Commission had rejected Moorman’s appeal from the revised assessment, appellant challenged the constitutionality of the single-factor formula in the Iowa District Court for Polk County. That court held the formula invalid under the Due Process Clause of the Fourteenth Amendment and the Commerce Clause. The Supreme Court of Iowa reversed, holding that an apportionment formula that is necessarily only a rough approximation of the income properly attributable to the taxing State is not subject to constitutional attack unless the taxpayer proves that the formula has produced an income attribution “out of all proportion to the business transacted” within the State. The court concluded that appellant had not made such a showing.

We noted probable jurisdiction of Moorman’s appeal, 434 U. S. 953, and now affirm.

II

Appellant contends that Iowa’s single-factor formula results in extraterritorial taxation in violation of the Due Process Clause. This argument rests on two premises: first, that appellant’s Illinois operations were responsible for some of the profits generated by sales in Iowa; and, second, that a formula that reaches any income not in fact earned within the borders of the taxing State violates due process. The first premise is speculative and the second is foreclosed by prior decisions of this Court.

Appellant does not suggest that it has shown that a significant portion of the income attributed to Iowa in fact was generated by its Illinois operations; the record does not contain any separate accounting analysis showing what portion of appellant’s profits was attributable to sales, to manufacturing, or to any other phase of the company’s operations. But appellant contends that we should proceed on the assumption that at least some portion of the income from Iowa sales was generated by Illinois activities.

Whatever merit such an assumption might have from the standpoint of economic theory or legislative policy, it cannot support a claim in this litigation that Iowa in fact taxed profits not attributable to activities within the State during the years 1968 through 1972. For all this record reveals, appellant’s manufacturing operations in Illinois were only marginally profitable during those years and the high-volume sales to Iowa customers from Iowa warehouses were responsible for the lion’s share of the income generated by those sales. Indeed, a separate accounting analysis might have revealed that losses in Illinois operations prevented appellant from earning more income from exploitation of a highly favorable Iowa market. Yet even were we to assume that the Illinois activities made some contribution to the profitability of the Iowa sales, appellant’s claim that the Constitution invalidates an apportionment formula whenever it may result in taxation of some income that did not have its source in the taxing State is incorrect.

The Due Process Clause places two restrictions on a State’s power to tax income generated by the activities of an interstate business. First, no tax may be imposed unless there is some minimal connection between those activities and the taxing State. National Bellas Hess, Inc. v. Department of Revenue, 386 U. S. 753, 756. This requirement was plainly satisfied here. Second, the income attributed to the State for tax purposes must be rationally related to “values connected with the taxing State.” Norfolk & Western R. Co. v. State Tax Comm’n, 390 U. S. 317, 325.

Since 1934 Iowa has used the formula method of computing taxable income. This method, unlike separate accounting, does not purport to identify the precise geographical source of a corporation’s profits; rather, it is employed as a rough approximation of a corporation’s income that is reasonably related to the activities conducted within the taxing State. The single-factor formula used by Iowa, therefore, generally will not produce a figure that represents the actual profits earned within the State. But the same is true of the Illinois three-factor formula. Both will occasionally over-reflect or under-reflect income attributable to the taxing State. Yet despite this imprecision, the Court has refused to impose strict constitutional restraints on a State’s selection of a particular formula.⁶

Thus, we have repeatedly held that a single-factor formula is presumptively valid. In Underwood Typewriter Co. v. Chamberlain, 254 U. S. 113, for example, the taxpayer challenged Connecticut’s use of such a formula to apportion its net income. Underwood’s manufacturing operations were conducted entirely within Connecticut. Its main office, however, was in New York City and it had branch offices in many States where its typewriters were sold and repaired. Applying a single-factor property formula, Connecticut taxed 47% of the company’s net income. Claiming that 97% of its profits were generated by transactions in tangible personal property outside Connecticut, Underwood contended that the formula taxed “income arising from business conducted beyond the boundaries of the State” in violation of the Due Process Clause. Id., at 120.

Rejecting this claim, the Court noted that Connecticut “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,” id., at 121, and held that the taxpayer had failed to carry its burden of proving that “the method of apportionment adopted by the State was inherently arbitrary, or that its application to this corporation produced an unreasonable result.” Ibid, (footnote omitted) 7

In individual cases, it is true, the Court has found that the application of a single-factor formula to a particular taxpayer violated due process. See Hans Rees’ Sons, Inc. v. North Carolina ex rel. Maxwell, 283 U. S. 123; Norfolk & Western R. Co. v. State Tax Comm’n, supra. In Hans Rees’, for example, the Court concluded that proof that the formula produced a tax on 83% of the taxpayer’s income when only 17% of that income actually had its source in the State would suffice to invalidate the assessement under the Due Process Clause. But in neither Hans Rees’ nor Norfolk & Western did the Court depart from the basic principles that the States have wide latitude in the selection of apportionment formulas and that a formula-produced assessment will only be disturbed when the taxpayer has proved by “clear and cogent evidence” that the income attributed to the State is in fact “out of all appropriate proportions to the business transacted ... in that State,” 283 U. S., at 135, or has “led to a grossly distorted result,” 390 U. S., at 326.

General Motors Corp. v. District of Columbia, 380 U. S. 553, on which appellant relies, does not suggest a contrary result. In that case the Court held that a regulation prescribing a single-factor sales formula was not authorized by the District of Columbia Code. It concluded that the formula violated the statutory requirement that the net income of a corporation doing business both inside and outside the District must be deemed to arise from “sources” both inside and outside the District. But that statutory requirement has no counterpart in the Constitution, and the Court in General Motors made clear that it did “not mean to take any position on the constitutionality of a state income tax based on the sales factor alone.” Id., at 561.⁸

The Iowa statute afforded appellant an opportunity to demonstrate that the single-factor formula produced an arbitrary result in its case. But this record contains no such showing and therefore the Director’s assessment is not subject to challenge under the Due Process Clause.⁹

Ill

Appellant also contends that during the relevant years Iowa and Illinois imposed a tax on a portion of the income derived from the Iowa sales that was also taxed by the other State in violation of the Commerce Clause.¹⁰ Since most States use the three-factor formula that Illinois adopted in 1970, appellant argues that Iowa’s longstanding single-factor formula must be held responsible for the alleged duplication and declared unconstitutional. We cannot agree.

In the first place, this record does not establish the essential factual predicate for a claim of duplicative taxation. Appellant’s net income during the years in question was approximately $9 million. Since appellant did not prove the portion derived from sales to Iowa customers, rather than sales to customers in other States, we do not know whether Illinois and Iowa together imposed a tax on more than 100% of the relevant net income. The income figure that appellant contends was subject to duplicative taxation was computed by comparing gross sales in Iowa to total gross sales. As already noted, however, this figure does not represent actual profits earned from Iowa sales. Obviously, all sales are not equally profitable. Sales in Iowa, although only 20%> of gross sales, may have yielded a much higher percentage of appellant’s profits. Thus, profits from Iowa sales may well have exceeded the $2.5 million figure that appellant contends was taxed by the two States. If so, there was no duplicative taxation of the net income generated by Iowa sales. In any event, on this record its existence is speculative.¹¹

Even assuming some overlap, we could not accept appellant's argument that Iowa, rather than Illinois, was necessarily at fault in a constitutional sense. It is, of course, true that if Iowa had used Illinois’ three-factor formula, a risk of duplication in the figures computed by the two States might have been avoided. But the same would be true had Illinois used the Iowa formula. Since the record does not reveal the sources of appellant’s profits, its Commerce Clause claim cannot rest on the premise that profits earned in Illinois were included in its Iowa taxable income and therefore the Iowa formula was at fault for whatever overlap may have existed. Rather, the claim must be that even if the presumptively valid Iowa formula yielded no profits other than those properly attributable to appellant’s activities within Iowa, the importance of avoiding any risk of duplication in the taxable income of an interstate concern justifies invalidation of the Iowa statute.

Appellant contends that, to the extent this overlap is permitted, the corporation that does business in more than one State shoulders a tax burden not shared by those operating entirely within a State.¹² To alleviate the burden, appellant invites us to hold that the Commerce Clause itself, without implementing legislation by Congress, requires Iowa to compute corporate net income under the Illinois equally weighted, three-factor formula. For the reasons that follow, we hold that the Constitution does not require such a result.

The only conceivable constitutional basis for invalidating the Iowa statute would be that the Commerce Clause prohibits any overlap in the computation of taxable income by the States. If the Constitution were read to mandate such precision in interstate taxation, the consequences would extend far beyond this particular case. For some risk of duplicative taxation exists whenever the States in which a corporation does business do not follow identical rules for the division of income. Accepting appellant’s view of the Constitution, therefore, would require extensive judicial lawmaking. Its logic is not limited to a prohibition on use of a single-factor apportionment formula. The asserted constitutional flaw in that formula is that it is different from that presently employed by a majority of States and that difference creates a risk of duplicative taxation. But a host of other division-of-income problems create precisely the same risk and would similarly rise to constitutional proportions.

Thus, it would be necessary for this Court to prescribe a uniform definition of each category in the three-factor formula. For if the States in which a corporation does business have different rules regarding where a “sale” takes place, and each includes the same sale in its three-factor computation of the corporation’s income, there will be duplicative taxation despite the apparent identity of the formulas employed.¹³ A similar risk of multiple taxation is created by the diversity among the States in the attribution of “nonbusiness” income, generally defined as that portion of a taxpayer’s income that does not arise from activities in the regular course of its business.¹⁴ Some States do not distinguish between business and non-business income for apportionment purposes. Other States, however, have adopted special rules that attribute nonbusiness income to specific locations. Moreover, even among the latter, there is diversity in the definition of nonbusiness income and in the designation of the locations to which it is deemed attributable. The potential for attribution of the same income to more than one State is plain.¹⁵

The prevention of duplicative taxation, therefore, would require national uniform rules for the division of income. Although the adoption of a uniform code would undeniably advance the policies that underlie the Commerce Clause, it would require a policy decision based on political and economic considerations that vary from State to State. The Constitution, however, is neutral with respect to the content of any uniform rule. If division-of-income problems were to be constitutionalized, therefore, they would have to be resolved in the manner suggested by appellant for resolution of formula diversity — the prevalent practice would be endorsed as the constitutional rule. This rule would at best be an amalgam of independent state decisions, based on considerations unique to each State. Of most importance, it could not reflect the national interest, because the interests of those States whose policies are subordinated in the quest for uniformity would be excluded from the calculation.¹⁶

While the freedom of the States to formulate independent policy in this area may have to yield to an overriding national interest in uniformity, the content of any uniform rules to which they must subscribe should be determined only after due consideration is given to the interests of all affected States. It is clear that the legislative power granted to Congress by the Commerce Clause of the Constitution would amply justify the enactment of legislation requiring all States to adhere to uniform rules for the division of income. It is to that body, and not this Court, that the Constitution has committed such policy decisions.

Finally, it would be an exercise in formalism to declare appellant’s income tax assessment unconstitutional based on speculative concerns with multiple taxation. For it is evident that appellant would have had no basis for complaint if, instead of an income tax, Iowa had imposed a more burdensome gross-receipts tax on the gross receipts from sales to Iowa customers. In Standard Pressed Steel Co. v. Washington Revenue Dept., 419 U. S. 560, the Court sustained a tax on the entire gross receipts from sales made by the taxpayer into Washington State. Because receipts from sales made to States other than Washington were not included in Standard Pressed Steel’s taxable gross receipts, the Court concluded that the tax was “ 'apportioned exactly to the activities taxed.’ ” Id., at 564.

In this case appellant’s actual income tax obligation was the rough equivalent of a 1 % tax on the entire gross receipts- from its Iowa sales. Thus, the actual burden on interstate commerce would have been the same had Iowa imposed a plainly valid gross-receipts tax instead of the challenged income tax. Of more significance, the gross-receipts tax sustained in Standard Pressed Steel and General Motors Corp. v. Washington, 377 U. S. 436, is inherently more burdensome than the Iowa income tax. It applies whether or not the interstate concern is profitable and its imposition may make the difference between profit and loss. In contrast, the income tax is only imposed on enterprises showing a profit and the tax obligation is not heavy unless the profits are high.

Accordingly, until Congress prescribes a different rule, Iowa is not constitutionally prohibited from requiring taxpayers to prove that application of the single-factor formula has produced arbitrary results in a particular case.

The judgment of the Iowa Supreme Court is affirmed.

So ordered.

1 The statute provides:

“Interest, dividends, rents, and royalties (less related expenses) received in connection with business in the state, shall be allocated to the state, and where received in connection with business outside the state, shall be allocated outside of the state.” Iowa Code §422.33 (1) (a) (1977).

In describing this section, the Iowa Supreme Court stated that “certain income, the geographical source of which is easily identifiable, is allocated to the appropriate state.” 254 N. W. 2d 737, 739. Thus, for example, rental income would be attributed to the State where the property was located. And in appellant’s case, this section operated to exclude its investment income from the tax base.

2 Iowa Code §422.33 (1) (6) (1977).

3 The operation of the two formulas may be briefly described. The single-factor sales formula yields a percentage representing a ratio of gross sales in Iowa to total gross sales. The three-factor formula yields a percentage representing an average of three ratios: property within the State to total property, payroll within the State to total payroll, and sales within the State to total sales.

These percentages are multiplied by the adjusted total net income to arrive at Iowa taxable net income. This net income figure is then multiplied by the tax rate to compute the actual tax obligation of the taxpayer.

4 For those years the two formulas resulted in the following percentages:

For a description of how these percentages are computed, see n. 3, supra.

5 Thus, in 1968, for example, Moorman’s three-factor computation resulted in a tax of $81,466, whereas the Director’s single-factor computation resulted in a tax of $121,363.

6 See, e. g., Underwood Typewriter Co. v. Chamberlain, 254 U. S. 113; Bass, Ratcliff & Gretton, Ltd. v. State Tax Comm’n, 266 U. S. 271; Ford Motor Co. v. Beauchamp, 308 U. S. 331.

7 See also Bass, Ratcliff & Gretton, Ltd. v. State Tax Comm’n, supra; Norfolk & Western R. Co. v. North Carolina ex rel. Maxwell, 297 U. S. 682.

8 The Court, it is true, expressed doubts about the wisdom of the economic assumptions underlying the challenged formula and noted that its use in the context of the more prevalent three-factor formula would not advance the policies underlying the Commerce Clause. But these considerations were deemed relevant to the question of legislative intent, not constitutional interpretation.

9 In his concurring opinion, Justice McCormick of the Iowa Supreme Court made this point:

“In the present case, Moorman did not attempt to prove the amount of its actual net income from Iowa, activities in the years involved. Therefore no basis was presented for comparison of the corporation’s Iowa income and the income apportioned to Iowa under the formula. In this era of sophisticated accounting techniques, it should not be impossible for a unitary corporation to prove its actual income from activities in a particular state. However, Moorman showed only that its tax liability would be substantially less if Iowa employed a three-factor apportionment formula. We have no basis to assume that the three-factor formula produced a result equivalent to the corporation’s actual income from Iowa activities. Having failed to establish a basis for comparison of its actual income in Iowa with the income apportioned to Iowa under the single-factor formula, Moorman did not demonstrate that the single-factor formula produced a grossly unfair result. Thus it did not prove unconstitutionality of the formula as applied.” 254 N. W. 2d, at 757.

10 Since Illinois did not adopt its income tax until 1970, there was no possibility of any overlap until that year. The alleged overlap in the three years following Illinois’ enactment of an income tax was 34.38% in 1970, 34.51% in 1971, and 37.01% in 1972.

11 Since there is no evidence in the record regarding the percentages of its total net income taxed in the other States in which it did business during those years, any claim that appellant was taxed on more than 100% of its total net income would also be speculative.

12 Appellant also contends that the Iowa formula discriminates against interstate commerce in violation of the Commerce Clause and the Equal Protection Clause, because an Illinois corporation doing business in Iowa must pay tax on a greater portion of its income than a local Iowa company, and an Iowa company doing business in Illinois will pay tax on less of its income than an Illinois corporation doing business in Iowa. The simple answer, however, is that whatever disparity may have existed is not attributable to the Iowa statute. It treats both local and foreign concerns with an even hand; the alleged disparity can only be the consequence of the combined effect of the Iowa and Illinois statutes, and Iowa is not responsible for the latter.

Thus, appellant’s “discrimination” claim is simply a way of describing the potential consequences of the use of different formulas by the two States. These consequences, however, could be avoided by the adoption of any uniform rule; the “discrimination” does not inhere in either State’s formula.

13 Thus, while some States such as Iowa assign sales by destination, “sales can be assigned to the state ... of origin, the state in which, the sales office is located, the state where an employee of the business making the sale carries on his activities or where the order is first accepted, or the state in which an interstate shipment is made.” Note, State Taxation of Interstate Businesses and the Multistate Tax Compact: The Search for a Delicate Uniformity, 11 Colum. J. Law & Soc. Prob. 231, 237 n. 20 (1975) (citation omitted).

14 See, e. g., Uniform Division of Income for Tax Purposes Act § 1 (a).

15 Thus, one State in which a corporation does business may consider a particular type of income business income and simply include it in its apportionment formula; a second State may deem that same income nonbusiness income and attribute it to itself as the “commercial domicile” of the company; and a third State, though also considering it nonbusiness income, may attribute it to itself as the “legal domicile” of the company. See Note, supra n. 13, at 239.

16 This process is especially unsettling if a longstanding tax policy of one State, such as Iowa’s, becomes the object of constitutional attack simply because it is different from the recently adopted practice of its neighbor.