OHIO BOARD OF TAX APPEALS Global Industrial Technologies, ) CASE NO. 97-K-1072 fka Indresco, Inc., & also fka ) Dresser Finance Corp., ) (FRANCHISE TAX) ) Appellant, ) DECISION AND ORDER ) vs. ) ) Roger W. Tracy, Tax ) Commissioner of Ohio, ) ) Appellee. ) APPEARANCES: For the Appellant - Mark A. Engel Mary Leslie Robins Bricker & Eckler LLP 100 South Third Street Columbus, Ohio 43215-4291 For the Appellee - Betty D. Montgomery Attorney General of Ohio By: Richard C. Farrin Assistant Attorney General State Office Tower-16 th Floor 30 East Broad Street Columbus, Ohio 43215 Entered June 30, 1999 Mr. Johnson, Ms. Jackson and Mr. Manoranjan concur. This cause and matter is before the Board of Tax Appeals as a result of a notice of appeal having been filed on behalf of the above-named appellant 1 on August 27, 1997. Appellant appeals a final determination of the Tax Commissioner, 1 Although identified collectively as appellant, the various entities comprising it will be discussed herein.
dated July 10, 1997, wherein that official allowed in part and denied in part appellant s objections to franchise tax assessments issued for tax years 1990 through 1993. We now proceed to consider this matter based upon appellant s notice of appeal, the statutory transcript certified by the Tax Commissioner pursuant to R.C. 5717.02, the hearing conducted by this Board and the post-hearing brief submitted on behalf of appellant. Although accorded an opportunity to file written argument in support of his position, a brief on behalf of the Tax Commissioner has not been forthcoming. At this Board s hearing, appellant presented the testimony of three individuals: Thomas Zeller, tax attorney for Dresser Industries, Inc.; Michael Gilliland, Senior Manager of Corporate Taxes for Global Industrial Technologies Services Company; and Ronald Pottorf, Administrator of the Corporate Franchise Tax Audit Division of the Department of Taxation. The portion of the Tax Commissioner s final determination which addresses the point in issue provides, in pertinent part, as follows: On audit, the taxpayer s investment in Komatsu Dresser Company was allocated based on the ratio of the net book value of physical assets of the partnership inside and outside Ohio. The taxpayer contends that no portion of the partnership should be sitused to Ohio. This contention is not well taken. The taxpayer s investment in the partnership is in this state, if the reasoning of Society Corp. v. Limbach (February 5, 1993), B.T.A. No. 90-1290, unreported, is followed. The Board stated: 2
[ ]Historically, the general rule concerning the situs acquired by movables and intangibles for tax purposes was that such property follows the laws of the owner s domicile, as embodied in the Latin axiom mobilia sequuntur personum. Sparks-Withington Co. v. Glander (1948) 149 Ohio St. 442. The traditional exception to the above said rule is the principle of business situs; that is, the situs of certain property is in a place other than the owner s domicile if, through business use, a permanent attachment has been established to a foreign locality. [ ]The above said rule has been codified in Revised Code Section 5709.02, which reads, in part, as follows: [ ]The types of property used in and arising out of business transactions, and the fixing of the situs thereof is detailed in Revised Code 5709.03, which states, in applicable part: (Emphasis in original) Id., quoting Hamilton Lerner Shops, Inc. and Columbus Lerner Shops, Inc. v. Lindley (August 28, 1980), Case Nos. 78-A-203 and 78-A-204, unreported, affirmed (1981), 66 Ohio St. 2d 300.[ ] R.C. 5733.05(A) provides that for purposes of situsing intangible property, including capital investments, the Tax Commissioner shall be guided by R.C. 5709.02 and 5709.02. These provisions deal with the situsing of property subject to the former intangible property tax. Contracts of partnership, whether general or limited, were not subject to that tax. See R.C. 5701.06(C)(2). As there are no specific provisions in R.C. 5709.02 and 5709.03 for the situsing of partnership interests, and since R.C. 5709.02 and 5709.03 are based on the principle of business situs, those sections, together with the aggregate nature of partnerships for purposes of taxing the partners under R.C. Chapter 5733, provide guidance that partnership interests are to be sitused to the partnership s business 3
following as error: location, which in this case includes Ohio. Although the taxpayer objects to the use of the physical assets of the partnership in establishing the portion of the intangible partnership interest present in Ohio, it suggests no alternative. As R.C. 5709.02 and 5709.03 provide for situsing other intangibles based on the location of a taxpayer s physical assets, it is appropriate under R.C. 5733.05(A) to situs the taxpayer s interest in Komatsu Dresser Company. S.T. at 2-3. From the foregoing, appellant appealed to this Board, specifying the 1. Appellee unlawfully allocated the Appellant s partnership interest in Komatsu Dresser Company based upon the net book value of the physical assets of the partnership inside and outside Ohio. During the tax years in question, Appellant treated its ownership in the partnership as an investment on its books. Pursuant to R.C. 5733.05(A), R.C. 5709.02 and R.C. 5709.03, Appellant s entire interest in the partnership should have been allocated outside Ohio. 2. During the tax years in question, Appellant allocated its partnership interest in Komatsu Dresser Company pursuant to the existing policy of the Department of Taxation and consistent with the instructions accompanying the franchise tax reports for each tax year. As a result of this written policy, Appellee is estopped from retroactively changing its position with respect to the allocation of Appellant s partnership interest. 3. Appellee s retroactive attempt to change its position with respect to the allocation of Appellant s partnership interest in Komatsu Dresser Company constitutes a taking of Appellant s property without due process of law, contrary to both the fourteenth amendment to the Constitution of the United States and the Constitution of the State of Ohio. 4
As suggested by the case caption, appellant has undergone a variety of corporate changes. By way of background, appellant first indicated that Dresser Industries, Inc. ( Dresser ) was established under the laws of the State of Delaware, with both its principal place of business and its corporate books and records being located in Dallas, Texas. Appellant elaborated upon Dresser s operations by explaining that it is a large conglomerate which, at one time, had a variety of business interests, including those in the insurance, banking and heavy equipment manufacturing industries. Electing to specialize in the energy industry, over a ten year period, Dresser spun off and reorganized so as to divest itself of its other interests. With respect to its manufacturing operations, some of which were located in Ohio, Dresser had originally established Dresser Finance Corporation ( Dresser Finance ), a wholly-owned subsidiary, in order to finance its heavy equipment sales. Later, Dresser transferred its entire construction equipment division to Dresser Finance. Dresser Finance was also a Delaware corporation, registered to do business in every state, with its principal place of business located in Libertyville, Illinois. In 1988, due to a downturn in the construction equipment industry, as well as an overabundance of manufacturers in the industry, Dresser entered into a joint venture with Komatsu Ltd. Tokyo ( Komatsu ), a Japanese manufacturer of construction equipment. This venture was intended to allow Dresser to compete 5
more effectively in the construction equipment manufacturing industry. Under the terms of the joint venture, Dresser and Komatsu contributed their respective construction equipment divisions, via their respective subsidiaries, i.e., Dresser Finance and Komatsu America, to a newly formed U.S. partnership named Komatsu Dresser Company ( Komatsu Dresser ), which was headquartered in Libertyville, Illinois. In exchange, each of these subsidiaries obtained a fifty percent interest in the Komatsu Dresser partnership. 2 Due to Dresser Finance s inability to work successfully with its partner in the Komatsu Dresser partnership and a further downturn in the construction equipment industry, in 1992, Dresser reorganized Dresser Finance. In connection with this reorganization, Dresser changed the name of Dresser Finance to Indresco, Inc. ( Indresco ), once again a Delaware corporation with its principal place of business being located in Dallas, Texas. In addition to the name-change, Dresser contributed some additional assets to Indresco and distributed its shares of common stock in Indresco to its shareholders in accordance with their percentage 2 For years ending October 31, 1990 and October 31, 1991, the corporate books of Dresser Finance reflected a fifty percent ownership interest in Komatsu Dresser, as an Investment in Uncons. Co., i.e., an investment in unconsolidated companies. According to appellant s witness, Thomas Zeller, under generally accepted accounting principles ( GAAP ), an unconsolidated company is any company in which an investor has a twenty to fifty percent ownership interest. Dresser Finance utilized the equity method of accounting to report its investment in Komatsu Dresser. In doing so, it recorded its initial cost in the investment and adjusted the account of the unconsolidated company, i.e., Komatsu Dresser, to recognize its share of annual earnings or losses, typically shown as a single amount. Zeller contrasted this treatment of Dresser Finance s investment in Komatsu Dresser with a situation in which an investor owns more than fifty percent of a company. In such a scenario, the investor is required by GAAP to use the consolidated method of accounting wherein each individual partnership item of asset or liability flows through to the investor and would be reflected on the investor s books. 6
ownership in Dresser. As a result, Indresco was no longer a subsidiary of Dresser but was instead owned by Dresser s shareholders, having its own board of directors and management team. In 1995, Indresco went through its own reorganization whereby several of its operating divisions were spun off to newly incorporated subsidiaries. The only operating unit remaining, was the Harbison Walker Refractories Division. Indresco was then renamed the Harbison Walker Refractories Company ( Harbison Walker ). At the time of this reorganization, a holding company was created, i.e., Global Industrial Technologies ( Global ), which became the sole shareholder of Harbison Walker, or the former Indresco. Having briefly described the various reorganizations which took place, we now turn to the manner by which several of these taxpayers reported for purposes of Ohio s corporate franchise tax. Dresser prepared the Ohio Corporation Franchise Tax Reports ( Reports ) for Dresser Finance for 1990 through 1992, while the 1993 Report was prepared by Indresco as a separate corporation. During the period in question, i.e., 1991 through 1993, the corporate franchise tax liability of Dresser Finance and Indresco was based upon the net worth method, as opposed to the net income method. Schedule G of the 1991, 1992 and 1993 Reports contains the property and business allocation formula. In the Reports instructions, sent to taxpayers simultaneously with Reports themselves, the following instruction was included: 7
Do not include the taxpayer-partner s proportionate share of partnership property or partnership business done unless the taxpayer-partner reflects on its books of account its proportionate share of each partnership asset, liability, owner s equity account, and business done. (Emphasis sic.) Since both Dresser Finance and Indresco utilized the equity method of accounting, their books and records did not reflect the individual assets or liabilities of Komatsu Dresser. Indicating that reliance was placed upon the above-quoted instruction, Dresser Finance and Indresco did not reflect the value of their investment in Komatsu Dresser in the numerator of the net worth calculation required by Ohio s franchise tax scheme. They did, however, include the value of their investment in Komatsu Dresser in the denominator of this calculation. Following a review of their Reports, the Department of Taxation adjusted Schedule G in order to situs to Ohio appellant s investments in Komatsu Dresser using a ratio of net book value of physical assets within and without Ohio. At this Board s hearing, appellant presented evidence that during the period in question, the Department of Taxation, for purposes of calculating the net worth base of the corporate franchise tax, had two proposed methods for treatment of a taxpayer s less than fifty-one percent interest in a general partnership. Consistent with the adjustment made by the Department in the present case, one of the proposed rules sitused an interest in a partnership according to the location of the physical assets of the partnership without regard to the amount of the corporate taxpayer s ownership interest. The other proposed rule determined the situs of the 8
corporate taxpayer s interest pursuant to general situsing provisions based upon the amount of the taxpayer s interest in the partnership, i.e., an interest in a partnership would be sitused to Ohio only if the corporate taxpayer owned more than fifty-one percent of that partnership. Ron Pottorf admitted that it was likely that investments of similarly situated taxpayers received different treatment depending upon which of the proposed rules reasoning was applied. Appellant insists that its investment in the Komatsu Dresser partnership should not be sitused to Ohio for several reasons. First, appellant asserts that there exists no statutory or case authority which would require a foreign corporation to situs to Ohio its investments in a partnership in which it had less than a fifty-one percent interest. Second, to the extent there exists any ambiguity within the corporate franchise tax framework in this regard, it should be construed in appellant s favor. Third, the adjustments which were made by the Tax Commissioner so as to situs appellant s interests in Komatsu Dresser to Ohio were done pursuant to a proposed rule which was never properly promulgated. Fourth, due to his prior treatment of similar investments held by Dresser, as well as language contained in instructions accompanying his Corporate Franchise Tax Reports, the Tax Commissioner is estopped from making the adjustments which he did. Finally, situsing the intangible property of appellant to Ohio constitutes a taking of its property in violation of the United States and Ohio Constitutions. 3 3 With respect to appellant s third specification of error, through which the above-referenced claim is raised, the Board of Tax Appeals acts as a receiver of evidence for constitutional challenges, with 9
Franchise tax is an excise tax levied upon domestic and foreign for profit corporations for the privilege of exercising their corporate franchises in Ohio. R.C. 5733.01. Franchise tax is based upon the value of the issued and outstanding shares of stock of the taxpayer ***. Pursuant to R.C. 5733.05, this value is calculated using both the net worth and the net income bases. The franchise tax due is based upon the greater of these two amounts. R.C. 5733.06. At issue in this case is the calculation of appellant s franchise tax utilizing the net worth method. Under the net worth method, the taxpayer computes [t]he total value, as shown by the books of the company, of its capital, surplus, whether earned or unearned, undivided profits and reserves *** less certain exclusions. R.C. 5733.05. Corporations which own property located within and without Ohio must apportion net worth under a two factor formula so that the portion of net worth attributable to Ohio may be determined. The total net worth is apportioned in and out of Ohio by means of the property and business done factors. The property factor, at issue herein, is a fraction, the numerator representing the net book value of all the corporation s property owned or used by it in this state and the denominator representing the net book value of all its property wherever situated ***. R.C. 5709.02 provides that intangible property of persons residing in this state is subject to taxation in Ohio unless an exclusion set forth in R.C. Footnote contd. ultimate resolution of such claims being reserved to courts created by Article IV of the Ohio 10
5709.03, which fixes the situs of certain classes of property within and without the state, applies. These general provisions are made specifically applicable to corporate franchise taxpayers by virtue of R.C. 5733.05: In determining the value of intangible property, including capital investments, owned or used in this state by either a domestic or foreign corporation, the commissioner shall be guided by sections 5709.02 and 5709.03 of the Revised Code ***. Appellant is a Delaware corporation which maintains its principal place of business outside this state. Therefore, as a foreign corporation, appellant s intangible property is not sitused to Ohio unless a special situsing provision applies. None of the situsing provisions set forth in R.C. 5709.03 specifically address a corporate taxpayer s interest in a partnership. R.C. 5709.03 declares that only certain types of property, e.g., accounts receivable, prepaid items, accounts payable, certain types of deposits, money and investments, be considered to arise out of business transacted in a state other than that in which the owner resides ***. The only class of property within which appellant s interest in the Komatsu Dresser partnership could arguably be included is the general classification of investments. However, this argument must fail given the definition of investments set forth in R.C. 5701.06: As used in Title LVII [57] of the Revised Code, investments includes: Footnote contd. *** Constitution. See MCI Telecommunications Corp. v. Limbach (1994), 68 Ohio St.3d 195. 11
(C) Annuities, royalties, and other contractual obligations for the periodical payment of money and all contractual and other incorporeal rights of a pecuniary nature from which income is or may be derived, however evidenced, excepting: *** (2) Contracts *** of partnership ***. (Emphasis added.) To the extent any analogy may be drawn between appellant s investment in the Komatsu Dresser partnership and a corporate taxpayer s investment in a subsidiary corporation, which appears to be the case based upon one of the two proposed but never promulgated policies previously referenced, such analogy must fail. R.C. 5733.05(A) specifically indicates that a foreign corporation s investments in a subsidiary corporation of which its owns at least fiftyone percent of the common stock is to be allocated in and out of state in accordance with the value of physical property in and out of the state representing such investments, loans, and advances ***. In the present case, appellant had less than a fifty-one percent ownership interest in the Komatsu Dresser partnership. Since appellant is a Delaware corporation which maintains its principal place of business outside Ohio, it was not required to reflect its interest in the Komatsu Dresser partnership, a partnership in which it had less than a fifty-one percent ownership interest, in the numerator of the property factor described in R.C. 5733.05. 12
Based upon the foregoing, it is the decision of the Board of Tax Appeals that appellant s first specification of error is well-taken and is sustained. Given the conclusion which we have reached with respect to appellant s first specification of error, we need not address the remainder of its claimed errors. Accordingly, it is the order of this Board that the Tax Commissioner s final determination must be, and hereby, is reversed. ohiosearchkeybta 13