Comptroller of the Treasury v. Atlantic Supply Co.

Rodowsky, J., delivered the opinion of the Court. This is an income tax case. The issue is whether all of the business income of the corporate taxpayer is to be allocated to Maryland because "the trade or business of the [taxpayer] is carried on wholly within this State ...." Md. Code (1957, 1980 Repl. Vol.), Art. 81, § 316 (c). 1 For the tax years in ²¹⁵ issue, 1972-1976, the taxpayer reported its entire business income, apportioned part of it to Maryland, and paid taxes only on that portion it considered as taxable by Maryland.

The Comptroller of the Treasury, Income Tax Division (Comptroller) assessed additional taxes, with interest, on the ground that no part of the income was derived from business conducted in any other state. This assessment was affirmed by the Maryland Tax Court. On appeal, the Baltimore City Court reversed the Maryland Tax Court and vacated the assessment of additional taxes. We granted certiorari on our own motion prior to consideration of the Comptroller’s appeal by the Court of Special Appeals.

For reasons hereinafter stated, the judgment of the Baltimore City Court will be affirmed. Atlantic Supply Company (Atlantic) is the taxpayer. It is a wholly-owned subsidiary of The Macke Company (Macke-parent). Both Macke-parent and Atlantic are incorporated under the laws of the District of Columbia and each is qualified to do business in Maryland.

The principal business office of Macke-parent is located in Cheverly, Maryland. Macke-parent has many subsidiaries in addition to Atlantic, the number of which fluctuated during the tax years involved. We shall call Macke-parent, and all of its subsidiaries, including Atlantic, simply "Macke.” Macke is a "vendor, contract feeder.” Part, if not all, of its business is ²¹⁶ the retail sale of food and beverages through vending machines located on the commercial or industrial premises of others. Macke operates in 26 eastern states.

In each trading area there is a Macke branch, with a warehouse. The record is unclear whether each branch location is operated through a separate subsidiary of Macke-parent, but we shall adopt the terminology of the parties and utilize the term "Macke-branch” as synonymous with one of the subsidiary corporations which sells to ultimate consumers. Atlantic is not a Macke-branch. Indeed, Atlantic has no separate place of business, no payroll, no bank account and pays no dividends.

Atlantic was incorporated in order to obtain a wholesale price on purchases from The Coca-Cola Company (Coca-Cola). Coca-Cola considers the Macke-branches to be retailers and therefore ineligible for wholesale pricing were they to purchase directly from Coca-Cola. After Atlantic was formed, the director of purchasing of Macke-parent has, apparently periodically, negotiated wholesale prices for sale by Coca-Cola of its products to Atlantic. Thus, while each Macke-branch places orders in its own name with other suppliers, orders throughout Macke for Coca-Cola products are made in the name of Atlantic.

Preliminary to Coca-Cola selling at wholesale, it requires an application to be submitted. It is Atlantic which in each case applied for Atlantic to be treated as a wholesaler by Coca-Cola. There are as many such applications as there are Macke-branches. The address for Atlantic on any such application by Atlantic is that of the Macke-branch involved.

Atlantic states on each such application that the address so given is that of a branch of Atlantic, and that its home office is "P.O. Box 68, Hyattsville, Maryland 20781.” Atlantic is identified on the application as a subsidiary of Macke-parent. The principal business office of Macke-parent at Cheverly is also in postal zone 20781. Against this background, the procedure and accounting trail for the purchase of Coca-Cola products is as follows. An individual with purchasing responsibility at a ²¹⁷ Macke-branch telephones his local source of Coca-Cola products and orally places an order.

This is followed up by a written purchase order with the printed heading "the Macke Company.” The form contains a blank for "ordered by” in which is inserted Atlantic’s name and the address of the Macke-branch involved as Atlantic’s local address. This is also the address to which Coca-Cola is directed to ship. On the purchase order Coca-Cola is directed to bill to Atlantic at the post office box in Hyattsville. Coca-Cola physically delivers, or arranges delivery, to the Macke-branch location.

Coca-Cola mails its invoice to the post office box in Hyattsville, addressed to Atlantic in care of the Macke-branch involved. That invoice reflects that the order is shipped to Atlantic, care of the particular Macke-branch involved, at the branch address. The Hyattsville post office box is simply that and no more. Atlantic has no office there, nor any office that is exclusively its own, at any location.

Coca-Cola invoices are paid by the funds of Macke-parent from its office in Cheverly. (Atlantic has no bank account.) Physical processing in payment of the invoices from Coca-Cola to Atlantic is performed by employees on the payroll of Macke-parent. Payment of Coca-Cola’s invoices to Atlantic is ordinarily done in time to take advantage of a 2% discount for prompt payment that is available from Coca-Cola. The amount advanced by Macke-parent in payment of Coca-Cola’s invoices to Atlantic is inter-company invoiced by Macke-parent to Atlantic, so that Atlantic is charged by Macke-parent only to the extent of the discounted amount of the invoices, and not at their face amount.

Employees paid by Macke-parent then prepare inter-company invoices by which Atlantic charges the particular Macke-branch involved with the face amount of the Coca-Cola invoice, even though the amount transmitted by Macke-parent, and owed by Atlantic to Macke-parent, is the discounted amount. This practice creates receivables of Atlantic from the Macke-branches (for Coca-Cola products sold by Atlantic to the Macke-branches) in excess of the cost of the goods to Atlantic (as represented by Atlantic’s payables to Macke-parent). Therein lies one of the two types of income to Atlantic. ²¹⁸ For the tax years here involved, the Macke-branches never made payment on their accounts payable to Atlantic and Atlantic never made payment on its accounts payable to Macke-parent. However, the Macke practice or policy was to charge interest on inter-company obligations at a rate representative of the cost of money to Macke-parent on the average outstanding net balance of inter-company obligations during a given fiscal year.

The total amount of interest debited by Atlantic to the Macke-branches on the accumulated receivables held by Atlantic constitutes the second type of income to Atlantic that is involved in these proceedings. The problem in the instant case is the legal result which flows from the foregoing facts. If Atlantic’s business is carried on wholly in Maryland, its business income is not apportioned as Maryland and non-Maryland income, but rather Maryland taxes 100% of the income. If Atlantic’s business is carried on partially in any other state, then Maryland taxes only so much of Atlantic’s income as is apportionable to Maryland.

In the latter event, we need not determine whether or not the apportionment actually made by Atlantic on its tax return was proper. The Baltimore City Court struck down the Comptroller’s assessment of additional tax and did not disturb the amount of tax developed by Atlantic on its return. On this appeal the Comptroller does not contend that the apportionment calculation used by Atlantic was improper, but asserts only that Atlantic was not entitled to any apportionment whatsoever. In its analysis, the Maryland Tax Court, in relevant part, concluded: When a Macke subsidiary ... wishes to purchase Coca-Cola; an order is placed by the subsidiary with the Coca-Cola Company, which, in turn, invoices Atlantic Supply in Hyattsville, Maryland.

The invoice is paid by Macke .... The Coca-Cola is then shipped to the Macke subsidiary not to Atlantic. Atlantic has no employees and no offices. Atlantic’s dealings with Coca-Cola are handled by Macke employees in Cheverly, Maryland, including ²¹⁹ the price for the Coca-Cola.

Atlantic cannot conduct any business until an order is placed by another Macke subsidiary. Atlantic, when it does conduct business, engages only in book transactions. The Company has no bank accounts and does not distribute dividends. The Comptroller agrees that there is trade or business being carried on, but argues that it is not Atlantic who is performing this function.

The evidence introduced in this case supports the Comptroller’s position .... We note that while Atlantic and Macke are conducting a unitary business, separate filing is required by Section 295 of Article 81. [Emphasis added.] The Baltimore City Court took a different approach. It reasoned that [j]ust as Macke is able to allocate its income because it performs business partially within the state and partially without the state, I see Atlantic being in the same position. It is after all just a creature of law owing its entire existence to Macke and cannot in any sense be considered independent from Macke’s operation.

In our view the legal characterization by the Tax Court of the transactions is not correct. Before articulating our reasons for this conclusion, an explanation should be given for the artificial mold in which the Maryland income tax law requires the analysis to be cast. Article 81, § 295 obligates "[e]very corporation . . . (domestic and foreign) having any income allocable to this State” to file a return and provides that "[cjorporations . .. which are affiliated shall each file separate returns.” If Macke-parent, the Macke-branches and Atlantic could be, and were, required to file a consolidated return from which the consolidated business income would be apportioned between Maryland and other jurisdictions, ²²⁰ the microscopic examination of the legal niceties of Atlantic’s operations as a specific corporate entity would be avoided. 2 Once attention is focused specifically on Atlantic, it is apparent from the undisputed evidence that the trade or business of Atlantic is to purchase Coca-Cola products and sell them to the Macke-branches.

Its business was to confer a benefit on Macke-parent and on the Macke-branches, as part of the unitary business. By means of Atlantic, the unitary business is supplied with Coca-Cola products at a lower price than that which could have been obtained by the Macke-branches, acting either independently or in concert. The testimony and documents demonstrate that the sales by Coca-Cola are made to Atlantic, and that it is Atlantic which sells to the Macke-branches. The fact that Atlantic is never physically in possession of an inventory of Coca-Cola products is not material.

The course of doing business involved here is a series of sales contracts. Coca-Cola performs its contract of sale with Atlantic by delivery directly ²²¹ to the location of Atlantic’s customer. And each time an order is placed by which Atlantic buys from Coca-Cola, there is also a contract of sale between Atlantic and its customer, the Macke-branch, which is performed by Atlantic’s having caused Coca-Cola to deliver to the Macke-branch. When the Macke-branch and the Coca-Cola supplier are located in the same state, each of these simultaneous contracts are formed and