COMPTROLLER OF TREASURY, IT DIV. v. NCR Corp.

BISHOP, Judge. This case involves a dispute between appellant Comptroller of the Treasury (Comptroller) and appellee NCR Corpo ¹¹⁹ ration (NCR) over the assessment of Maryland corporate income taxes. The controversy began in 1976, when the Comptroller assessed NCR with additional Maryland corporate income taxes for the years 1972 through 1974 in the total amount of $30,315.00 plus interest. In 1980, the Comptroller again assessed NCR with additional Maryland corporate income taxes for the years 1975 through 1977, this time totalling $144,116.00 plus interest.

NCR appealed both assessments to the Tax Court, which affirmed in part and reversed in part. From the Tax Court’s decision, both parties appealed to the Circuit Court for Baltimore City, each contesting the particular aspects of the decision that were adverse to its interest. In a lengthy opinion and order, the circuit court upheld the Comptroller’s right to tax NCR’s royalty income and the dividend income that it received from its foreign subsidiaries in 1976 and 1977, but also held that NCR’s domestic placement interest income was not taxable; that NCR’s gross-up income for the year 1976 was not taxable; and that NCR was entitled to modification in its sales, payroll and property factors to reflect worldwide the factors which produced its royalty and foreign subsidiary dividends. As to the last matter, the circuit court remanded the case to the Tax Court to obtain the necessary evidence to make the appropriate modifications to NCR’s apportionment formula.

From the circuit court’s judgments, the Comptroller appealed to this Court and NCR filed a cross-appeal. NCR, however, has since decided not to pursue its appeal, so the only issues remaining are whether the circuit court erred when it ruled that: I. NCR may exclude gross-up for 1976 from its adjusted business income; II. NCR may exclude its domestic placement interest income from its adjusted business income; and III. If NCR’s foreign income is subject to formula apportionment by Maryland, then its sales, payroll and proper ¹²⁰ ty factors should be adjusted to reflect worldwide the factors that produced this income.

I. Background A. Statutory Scheme Maryland taxes, on an apportioned basis, the entire net income of a multijurisdictional corporation, which is generated by interstate as well as intrastate activities. MD.ANN.CODE art. 81, §§ 280A, 316(c) (1980). Such taxation on interstate activities is constitutional, if fairly apportioned. Mobil Oil Corporation v. Commissioner of Taxes, 445 U.S. 425 , 100 S.Ct. 1223 , 63 L.Ed.2d 510 (1980); Northwestern States Portland Cement Company v. Minnesota, 358 U.S. 450 , 79 S.Ct. 357 , 3 L.Ed.2d 421 (1959).

In apportioning the business income of a multijurisdictional corporation, the first step is to determine that corporation’s federal taxable income. MD.ANN.CODE art. 81, § 280A(a) (1980) (defining net income of a corporation as “the taxable income of such taxpayer as defined in the laws of the United States”) Once the federal taxable income has been ascertained, subsections (b) and (c) of article 81, section 280A of the Maryland Code require further additions and subtractions. At the time relevant to this case, the statute permitted the following subtractions from a corporation’s taxable income: There shall be subtracted from taxable income of the taxpayer the following items to the extent included in federal income: (1) operating revenue subject to gross receipts taxes imposed by this article (less related expenses) of railroads, other public utilities and contract carriers; (2) the amount of any refunds of income taxes paid to the State of Maryland, any other state, the District of Columbia, and any political subdivision of the State of Maryland and any other state; and (3) interest ¹²¹ income on obligations of the United States and its instrumentalities. MD.CODE ANN. art. 81, § 280A (1975).

Although not pertinent to the instant case, additional adjustments for income from real or tangible personal property and for capital gains and losses are to be made to federal taxable income pursuant to article 81, section 316(a) and (b) of the Maryland Code. If the corporation conducts its business solely within the jurisdiction of Maryland, the calculation stops at this point. The figure ascertained from the above computations represents the net business income on which an annual tax of seven percent is levied. Id. §§ 288(b) and (c), 316(c).

If, however, the corporation is multijurisdictional, in that the trade or business of the corporation is carried on partly within and partly without this State____ then an additional calculation becomes necessary: So much of the business income of the corporation as is derived from or reasonably attributable to the trade or business of the corporation carried on within this State, shall be allocated to this State and any balance of the business income shall be allocated outside this State. Id. § 316(c). To determine the allocable business income to Maryland, the statute provides the Comptroller with two alternate methods: “separate accounting” or “the three-factor formula of property, payroll and sales.” Id. The circumstances under which separate accounting is appropriate are limited: the corporation may employ this method, “where practicable, but never in the case of a unitary business.” Id.

When separate accounting is neither permissable nor practicable, the statute details a formula upon which the corporation must determine the proper allocation of income: ... where separate accounting is neither allowable nor practicable the portion of the business income of the corporation allowable to this State shall be determined in accordance with a three-factor formula of property, payroll and sales, in which each factor shall be given equal ¹²² weight and in which the property factor shall include rented as well as owned property and tangible personal property having a permanent situs within this State and used in the trade or business shall be included as well as real property. Id. In Xerox Corporation v. Comptroller of the Treasury, 290 Md. 126 , 428 A.2d 1208 (1980), the Court of Appeals explained this apportionment formula as follows: ... a corporation must compute its Maryland tax liability by using a three-factor (sales, property and payroll) apportionment formula, each “factor” being a fraction. The numerator of the sales factor, for example, is the amount of a corporation’s in-state sales; the denominator of the sales factor is the total amount of a corporation’s in-state and out-of-state sales.

The property and payroll factors are computed in the same manner. The three factors are averaged and the resulting fraction, expressed as a percentage, is multiplied by the corporation’s business income. The resulting dollar amount constitutes the business income apportioned to this State. 290 Md. at 130 , 428 A.2d 1208 . To the corporation’s apportioned income, the annual tax rate of seven percent is then applied.

From this statutory scheme, a multijurisdictional corporation must follow a two-step process in determining taxable income. First, the corporation must ascertain the total amount of its business income prior to allocation. In determining this preallocation amount, the corporate taxpayer begins with its federal taxable income, and then makes the appropriate adjustments, as the statute may require, pursuant to sections 280A and 316. Second, the corporation must then allocate the portion of its total income that is derived from trade or business within the State.

Although two methods of apportionment are available, the statutorily-mandated, three-factor formula must be applied whenever the corporation is a “unitary business” or the Comptroller determines that separate accounting is impractical. Once the method is determined, the corporation must then apply ¹²³ this apportionment factor to the preallocation net income in order to determine the amount of net income subject to tax. B. Facts NCR manufactures and sells business machines, equipment, and related supplies and services at the wholesale and retail levels. Its principal place of business and corporate headquarters are located in Dayton, Ohio.

For all six years at issue, NCR has maintained in Maryland several sales and service offices as well as a marketing-administrative office. Through a network of foreign international subsidiaries, NCR has developed a worldwide market for its products. Of the ten subsidiaries, NCR owns one hundred percent interest in nine and seventy percent interest in the other. Each subsidiary retains control of its local management and determines such matters as the credit lines of its customers, market penetration, local advertising and acceptance or rejection of sales and customers.

In contrast, NCR as the parent delineates the broad, global dimensions of this operation. Specifically, it controls the worldwide cooperative effort among the subsidiaries by setting guidelines for sales and establishing geographical sales locations. Moreover, NCR controls each subsidiary’s Board of Directors and its longterm borrowing activities. When necessary, appellee makes loans to the subsidiaries.

Pursuant to licensing agreements, NCR grants each subsidiary the right to manufacture and sell business machines and equipment patented by NCR. In addition, NCR must supply its subsidiaries with all research, engineering, patentable and unpatentable know-how, and trade secrets. In consideration for these valuable rights, each subsidiary must pay as a royalty a percentage of the gross sales of licensed NCR products that the subsidiary has sold. No royalty, however, is due until the subsidiary has actually sold such products.

Based on these facts, the Tax Court determined that NCR’s worldwide operations comprised a unitary business: ¹²⁴ The business displayed unity of ownership; unity of operation as evidenced by central management; unity of use in its centralized executive force; and dependency of the subsidiaries on the parent. Pursuant to article 81, § 316(c) of the Maryland Code, NCR was required as a multijurisdictional corporation with a unitary business to follow the two-step process outlined above in its computation of its taxable income. In its audits of NCR’s income tax returns for the years 1972 through 1977, the Comptroller took exception to NCR’s calculations and thus assessed additional taxes in the amount of $174,-421.00, plus interest. On appeal to this Court, both steps in the process remain in dispute.

First, the Comptroller contends that, in its calculation of preallocation income, it was improper for NCR to deduct two categories of income, gross up and domestic placement income, from its taxable business income. Second, the Comptroller contends that the second step of the process, i.e. the circuit court’s determination of the apportionment factor, was flawed. In particular, appellant contends that the circuit court erred in requiring the modification of NCR’s apportionment factor to reflect the property, payroll, and sales of its foreign subsidiaries. We will address each of these contentions in order, once we set forth the proper standard for reviewing determinations of the Tax Court.

II

Standard of Review of Tax Court’s Finding Article 81, section 229(o) of the Maryland Code enunciates the standard under which the circuit court, as well as this Court, must review the findings of the Tax Court: Decision of circuit court. — In any case, the circuit court for the county shall determine upon the record made in the Maryland Tax Court. The circuit court shall affirm the Tax Court order if it is not erroneous as a ¹²⁵ matter of law and if it is supported by substantial evidence appearing in the record. In other cases, the circuit court may affirm, reverse, remand, or modify the order appealed from. Pursuant to this standard, the degree of judicial scrutiny hinges upon the nature of the findings being reviewed.

As to questions of law, the reviewing court has unlimited power of review and is entitled to substitute its legal conclusions, if the Tax Court’s legal conclusions are erroneous. Ramsay Scarlett & Company v. Comptroller of the Treasury, 302 Md. 825, 834 , 490 A.2d 1296 (1985). On the other hand, factual findings receive considerable deference in that a reviewing court may not reverse the Tax Court’s factual findings if they are supported by substantial evidence. Ramsay Scarlett, 302 Md. at 834 , 490 A.2d 1296 .

Finally, mixed questions of law and fact receive an intermediate level of scrutiny: such findings must be sustained if “in light of substantial evidence appearing in the record, a reasoning mind could have reached the [Tax Court’s] conclusion.” Id. at 838 , 490 A.2d 1296 . This Court has had the opportunity on numerous occasions to apply the principles of section 229(o) as delineated by the Court of Appeals in Ramsay Scarlett. E.g. United Parcel Service, Inc. v. Comptroller of the Treasury, 69 Md.App. 458 , 518 A.2d 164 (1986); Comptroller of the Treasury v. World Book Childcraft International, Inc., 67 Md.App. 424, 436-42 , 508 A.2d 148 (1986); Matthew Bender & Company, Inc. v. Comptroller of the Treasury, 67 Md.App. 693, 703-12 , 509 A.2d 702 (1986).

In each instance, we followed a three-step analysis in our review of the Tax Court’s findings: 1. First, the reviewing court must determine whether the agency recognized and applied the correct principles of law governing the case. The reviewing court is not constrained to affirm the agency where its order “is premised solely upon an erroneous conclusion of law.” 2. Once it is determined that the agency did not err in its determination or interpretation of the applicable law, ¹²⁶ the reviewing court next examines the agency’s factual findings to determine if they are supported by substantial evidence, i.e., by such relevant evidence as a reasonable mind might accept as adequate to support a conclusion.

Id. At this juncture, the Ramsay, Scarlett court reminds us that “it is the agency’s province to resolve conflicting evidence, and, where inconsistent inferences can be drawn from the same evidence, it is for the agency to draw the inference.” 3. Finally, the reviewing court must examine how the agency applied the law to the facts. This, of course, is a judgmental process involving a mixed question of law and fact, and great deference must be accorded to the agency.

The test of appellate review of this function is “whether, ... a reasoning mind could reasonably have reached the conclusion reached by the [agency], consistent with a proper application of the [controlling legal principles]”. United Parcel Service, 69 Md.App. at 464-65 , 518 A.2d 164 (quoting World Book); Matthew Bender, 67 Md.App. at 705-06 , 509 A.2d 702 (quoting World Book); World Book, 67 Md.App. at 438-39 , 508 A.2d 148 . Proper application of this methodological approach is contingent upon the reviewing court’s distinguishing among the Tax Court’s factual findings, legal conclusions, and applications of fact to law. The failure to make these discriminations will preclude the reviewing court from assessing the Tax Court’s decision under the correct standard of review.

With these principles in mind, we examine the Tax Court’s determinations regarding the taxability of gross-up, the taxability of NCR’s domestic placement interest, and the modification of NCR’s apportionment formula to reflect worldwide values.

III

Taxation of Gross-up Gross-up is a concept that is employed in calculating a multinational corporation’s tax liability under Federal ¹²⁷ income tax law. Pursuant to sections 901-908 of the Internal Revenue Code (I.R.C.), domestic corporations that own at least ten percent of the voting stock of a foreign corporation from which it receives dividends has the option of claiming a foreign tax credit on the tax paid by its subsidiary to the foreign government. According to section 902 of the I.R.C., the domestic corporation “shall be deemed to have paid” a proportion of taxes actually paid or accrued by the foreign corporation. See generally 19 Fed.Tax Coordinator 2d (Res.Inst.Am.) 40,199-202; 34 AM.JUR.2D Federal Taxation § 8400 (1987).

If a corporate taxpayer elects to take the foreign tax credit, 1 section 78 of the I.R.C. requires the domestic corporation to add to its gross income the amount of the deemed paid foreign taxes before it takes the credit. This amount is commonly referred to as “gross-up”. See generally Taxation and Revenue Department of New Mexico v. F.W. Woolworth Company, 95 N.M. 519 , 624 P.2d 28, 30-31 (1981) (explaining concept of gross-up in which the amount of the credit taken for the taxes paid by foreign subsidiary is deemed to be received as dividends). In preparing its Maryland tax return for the year 1976, NCR did not include the gross-up figure as part of its business income.

On audit, the Comptroller determined that pursuant to article 81, section 280A of the Maryland Code, NCR should have included this amount in its apportionable Maryland income and thus levied a tax on this omitted income. Although the Tax Court affirmed the ¹²⁸ Comptroller’s disallowance of NCR’s deductions, the circuit court reversed, holding gross-up income is not taxable. Section 280A(a) provides “[t]he net income of á corporation shall be the taxable income of such taxpayer as defined in the laws of the United States.” Since section 78 of the I.R.C. requires NCR to include gross-up as part of federal taxable income, it is clear that gross-up is part of a business’ taxable income when computing the Maryland return. Notwithstanding this express statutory language, the circuit court refused to include gross-up as part of NCR’s apportionable Maryland income because of its “artificial” and “fictitious” nature: There is little doubt that the gross-up figure is an artificial one which does not represent particularized money or dividend income of NCR.

Even the United States Supreme Court has termed the gross-up figure “fictitious” and strictly used for federal foreign tax credit purposes. F W. Woolworth Co. [Taxation and Revenue Dept. of New Mexico ], 458 U.S. [354] at 372 [ 102 S.Ct. 3128, 3139 , 73 L.Ed.2d 819 (1982)]. The purpose of requiring a corporation which opts for the tax credit to make the artificial adjustments to its federal taxable income is to prevent a double benefit to the corporation. We recognize that in reviewing the Tax Court’s construction of section 280A, the circuit court possessed unlimited power of review and was thus authorized to substitute its legal conclusions for what it believed was the erroneous legal conclusions of the Tax Court.

This substitution, however, is contingent upon the Tax Court’s conclusion being erroneous as a matter of law. From our review of the statutory scheme, we agree with the Tax Court’s construction of section 280A. First, the plain meaning of section 280A clearly indicates that for 1976, NCR should have included gross-up as part of its taxable income in Maryland. Maryland income tax laws are “inextricably keyed” to the Internal Revenue Code.

Comptroller of the Treasury v. Diebold, 279 Md. 401, 408 , 369 A.2d 77 (1977); accord Marco Associates, Inc. ¹²⁹ v. Comptroller of the Treasury, 265 Md. 669, 674 , 291 A.2d 489 (1972) (stating that “the whole thrust of the Maryland Act is to impose a tax on the amount determined under the Internal Revenue Code as the adjusted gross income of an individual or the taxable income of the corporation”); Katzenberg v. Comptroller of the Treasury, 263 Md. 189, 204 , 282 A.2d 465 (1971) (quoting the same language as Marco); Comptroller of the Treasury v. Chesapeake Corporation of Virginia, 54 Md.App. 208, 218 , 458 A.2d 459 (1983) (noting that “Maryland income tax laws were written ‘with both eyes on the federal tax laws’ ”). An example of this interrelationship is section 280A(a), which provides that the amount a taxpayer reports on his federal taxable income is the amount on which the taxpayer computes its State income liability. This amount is binding on the taxpayer and must be used as the basis for determining Maryland taxes unless deductions are authorized pursuant to section 280A(c). For the years 1972-1975, section 280A(c)(4) authorized the deductions of gross-up by permitting taxpayers to subtract this “dividend interest”.

See Woolworth, 624 P.2d at 30-31 . For the year 1977 and thereafter, the statute provides a more precise authorization to deduct gross-up: a taxpayer is entitled to subtract “any amounts included therein by operation of the provisions of § 78 of the Internal Revenue Code of 1954.” Conspicuously absent, however, is the existence of an exclusion for the year 1976, the taxable year in which the deduction of gross-up is at issue. The omission of a gross-up deduction is significant. Without explicit authorization to exclude gross-up income, corporations like NCR must include it as part of their Maryland taxable income.

The circuit court’s construction of the statute to the contrary is without merit. In its attempt to address the obvious absence of any statutory authority for NCR’s deduction of gross-up, the circuit court simply hypothesized as to the true intent of the legislature when drafting the 1976 version of section 280A(c): This Court agrees with NCR that the one year lapse in legislative action did not constitute an intentional taxing ¹³⁰ of corporate dividend gross-up. Rather, the Legislature’s inaction for the 1976 tax year was unintended. Such an extensive revision of a statute, however, exceeds the bounds of judicial authority.

It is well established in Maryland that “courts may not surmise a legislative intention contrary to the plain language of the statute, nor insert or omit words to make the statute express an intention not evident in its original form.” Government Employees Insurance Company v. Insurance Commissioner of Maryland, 273 Md. 467 , 480, 330 A.2d 653 (1974); accord Board of Education of Garrett County v. Lendo, 295 Md. 55, 62-63 (1982); Baltimore Building and Construction Trades Council AFL-CIO v. Barnes, 290 Md. 9, 15 , 427 A.2d 979 (1981); Saint Paul Fire & Marine Insurance Company v. Insurance Commissioner of Maryland, 275 Md. 130, 141-42 , 339 A.2d 291 (1975). Without a specific authorization to subtract gross-up income, the circuit court had no power to permit NCR’s deduction of gross-up from its Maryland tax return. Second, although the issue is one of first impression in Maryland, a multitude of courts in other jurisdictions have recognized that a state may subject gross-up income to taxation. Albany International Corporation v. Halperin, 388 A.2d 902, 905-06 (Me.1978); Caterpillar Tractor Company v. Lenckos, 77 Ill.App.3d 90 , 32 Ill.Dec. 786 , 395 N.E.2d 1167, 1176 (1979), affd. 84 Ill.2d 102 , 49 Ill.Dec. 329 , 417 N.E.2d 1343 (1981), appeal dismissed sub nom.

Chicago Bridge & Iron Company v. Caterpillar Tractor Company, 463 U.S. 1220 , 103 S.Ct. 3562 , 77 L.Ed.2d 1402 (1983); Woolworth, 624 P.2d at 32-33 , rev’d on other grounds, 458 U.S. 354 , 102 S.Ct. 3128 , 73 L.Ed.2d 819 (1982); Commonwealth v. Westinghouse Electric Corporation, 478 Pa. 491 , 386 A.2d 491, 492-93 , appeal dismissed, 349 U.S. 805 , 99 S.Ct. 61 , 58 L.Ed.2d 97 (1978). Overlooking this precedent, however, the circuit court relied on In re Appeal of Norris Knosher, 139 Vt. 285 , 428 A.2d 1104 (1981), in which the Supreme Court of Vermont permitted a taxpayer to determine its Vermont income tax liability by recomputing his ¹³¹ federal income tax liability. Although this case did not involve gross-up income, the circuit court found the import of Knosher was compelling by analogy, for the purpose of interpreting the Maryland statute. According to the facts of Knosher, the taxpayer received a partial tax credit for wages paid to certain new employees.

In exchange for the tax credit, section 280C of the I.R.C. required the taxpayer not to claim a deduction for wages paid to the extent of the credit allowed. 428 A.2d at 1104. Because section 280C required the taxpayer to report his federal income in excess of his actual earnings, the court permitted the taxpayer to recalculate his federal tax liability as if he had taken a deduction for those wages rather than a credit. Id. at 1105-06. This precedent, in addition to being contrary to the plain meaning of the statute, is the minority rule.

Accordingly, we do not view it as persuasive.

IV

Domestic Placement Interest NCR received total interest income of $17,856,121.00 in 1976 and $22,138,461.00 in 1977. Of that income, $6,440,-986.00 in 1976 and $4,044,691.00 in 1977, were from unitary sources such as finance charges, loans and advances to subsidiaries, and loans and advances to agents. Since these investments were directly involved in the sale of business machines, appellee concedes that they are subject to Maryland apportionment. A large portion of NCR’s interest income, $11,415,135.00