Appeal from judgment of Court of Common Pleas of Dauphin County, No. 207 Commonwealth Docket, 1965, in case of Commonwealth v. Hellertown Manufacturing Company.
Herbert L. Levy, with him Robert Margolis, for appellant.
George W. Keitel, Deputy Attorney General, with him William C. Sennett, Attorney General, for Commonwealth, appellee.
Bell, C. J., Cohen, Eagen, O'Brien, Roberts and Pomeroy, JJ. Opinion by Mr. Justice Cohen. Mr. Justice Jones took no part in the consideration or decision of this case. Dissenting Opinion by Mr. Justice Roberts.
This appeal by Hellertown Manufacturing Company (Hellertown) involves the proper computation of its Pennsylvania corporate net income tax for the year 1961.
Hellertown is a Delaware corporation registered to do business in Pennsylvania with manufacturing facilities located in Hellertown, Pa. It is a wholly-owned subsidiary of Champion Spark Plug Company (Champion) a Delaware corporation located in Ohio. Hellertown's sole business activity involves the manufacture of spark plugs and allied products, all of which are sold by it to Champion and shipped by it to Champion's customers on orders of Champion.
In its corporate net income tax report for 1961 Hellertown allocated all of its tangible property and all of its wages, salaries, etc., to Pennsylvania while allocating over 98% of its gross receipts to Ohio. The Pennsylvania taxing officials (Commonwealth) disallowed all allocations and taxed Hellertown's income 100% in Pennsylvania. The tax as computed by Hellertown was $18,809.94; as computed by the Commonwealth it was $28,029.57; the difference is $9,219.63.
The settlement by the Commonwealth proceeds on the assumption that all of Hellertown's business is transacted in Pennsylvania. Therefore, pursuant to § 2 of the Corporate Net Income Tax Act of May 16, 1935, P. L. 208, as amended, 72 P.S. § 3420b (Act), the only correct way to compute Hellertown's tax, says the Commonwealth, is to apply the tax rate of 6% directly to federal taxable income of $467,159.14.
Hellertown, to the contrary, insists that not all of its business is transacted in Pennsylvania. Therefore, according to § 2 of the Act, the only correct way to compute its tax, says Hellertown, is to apply the allocation fractions permitted by the Act in such a case to the federal taxable income. Conceding that all of its tangible property and all of its wages and salaries are allocable to Pennsylvania, Hellertown, nevertheless, insists that virtually all of its gross receipts are negotiated or effected by its agents located at an office maintained by it in Ohio and that its allocation of these gross receipts outside of Pennsylvania is thus properly made in accordance with the statute.
Obviously, the facts are important. They are undisputed here. Hellertown was incorporated in 1950 and began its operations in Pennsylvania in 1951. From that date on it engaged in the manufacture of spark plugs which were imprinted with the name "Champion," which were ordered by and sold to Champion to the extent of Hellertown's complete output, which were
sold by Champion to its customers and shipped by Hellertown directly to those customers at Champion's order and which were billed by Hellertown to Champion and paid for by Champion to Hellertown. None of the ultimate sales by Champion to its customers of spark plugs manufactured by Hellertown were sold or shipped to buyers located in Pennsylvania.
Hellertown's affairs are governed by five officers: a president, vice-president, treasurer, secretary and assistant secretary. The first four of these are the same persons as are the president, vice-president, treasurer and secretary of Champion. The assistant secretary of Hellertown, who is not an officer of Champion, is general manager of Hellertown's manufacturing plant in Hellertown, Pa. This last officer also resides in Hellertown; the other four all reside in Toledo, Ohio.
Champion owns an office building in Toledo where the four joint officers have offices. Hellertown's name is on the door of this building. Correspondence between Toledo and Hellertown always is on stationery showing Hellertown, Pa., as Hellertown's address; correspondence with third persons is sometimes on similar stationery, sometimes on other stationery which contains a legend that replies be addressed to Toledo. At this Toledo office persons on Champion's direct payroll provide Hellertown with administrative, research, engineering and factory management services; with engineering and research on spark plug design, application and materials; with drawings and blue prints; and with time study standards. New machinery for the Hellertown plant is designed and ordered at Toledo. Staff at Toledo sets inspection and material standards and writes production specifications for all spark plugs.
These Toledo employees of Champion, together with the above-mentioned officers of both companies, determine all of Hellertown's employment and personnel
policies, conduct its labor negotiations, establish its budget and generally fix and carry out all of its executive and administrative polices. These last include, among other things, insurance negotiations, decisions regarding legal and accounting problems and all F.T.C. and I.C.C. matters.
In 1961, Hellertown paid Champion a "management fee" of $548,331.87. This figure represented 15% of the direct cost of labor and materials entering into Hellertown's production activities and was fixed by oral agreement between Hellertown and Champion. According to the record, this fee is paid to Champion for the various services described above as well as for a rental factor for the Toledo offices.
Although we have already mentioned how sales of spark plugs are handled by Champion and Hellertown, the parties went into the procedure in great detail; and in order to present as clear a picture as possible, we shall also summarize the procedure more fully. All spark plug orders are received by Champion in Toledo. Champion's employees process the orders and decide whether they are to be filled by Hellertown or from one of Champion's other production facilities. If Hellertown is selected, instructions are forwarded to it from Toledo. Hellertown (which usually has a large inventory of finished spark plugs on hand) ships the goods directly to Champion's customer, notifies Champion and bills it for the shipment according to a pricing schedule supplied by Hellertown's officers in Toledo. Champion bills the customer directly from Toledo and handles all credit and collection problems from there.
Finally, Hellertown showed that it had registered to do business in Ohio and paid Ohio its minimum franchise tax.
Based upon these various facts, the court below held that (1) Hellertown was not "transacting business"
outside of Pennsylvania, and thus, could not use the apportionment fractions, (2) Hellertown "negotiated" no sales and (3) Hellertown "effected" no sales from any location but Hellertown. Points (2) and (3) obviously were unnecessary conclusions after point (1) was stated; but the references to these other points illustrate some of the difficulties inherent in this situation. We shall discuss them below.
The problem is purely statutory. If all of Hellertown's business is transacted in Pennsylvania, its corporate net income tax is computed by applying the tax rate directly to federal taxable income (less any special deductions not involved here). If all of its business is not transacted in Pennsylvania, it is entitled to allocate in accordance with the traditional three-fraction formula (Hellertown had no capital gains or losses subject to special allocation). Under this formula tangible property is allocated to the state of location; wages of employees are allocated to Pennsylvania unless the employees are situate at, sent out from or connected with premises maintained by Hellertown outside of Pennsylvania; and gross receipts from sales are allocated to Pennsylvania unless the sales were negotiated or effected by agents of Hellertown situate at, sent out from or connected with premises maintained by Hellertown outside of Pennsylvania. We recently discussed aspects of these fractions in another appeal which raised questions concerning the meaning of the statutory language. Commonwealth v. General Foods Corporation, 429 Pa. 266, 239 A.2d 359 (1968).
Hellertown's problem involves a form of sequential reasoning. First, either all of its business is transacted in Pennsylvania or it is not. If it is, Hellertown may not allocate. If it is not, Hellertown may allocate. In the present context it must then prove that it maintains an office outside of Pennsylvania at, from or with which its agents are situate, sent out from or connected.
Finally, surmounting this hurdle, it must show that such agents negotiate or effect the gross receipts which it receives from Champion.
With respect to the first of these, we have little difficulty. Recently, in Commonwealth v. Tube City Iron and Metal Company, 432 Pa. 600, 248 A.2d 225 (1968), we dealt specifically with this issue of "transacting business" and ruled that it imposed a practical, not a technical, test. If the taxpayer is present (e.g. through administrative functioning, property owner-ship or sales activity) in some fashion outside of Pennsylvania and if this presence is related to its actual business activity, it is transacting business outside of Pennsylvania. This conclusion follows without reference to whether or not the taxpayer is "doing business" elsewhere ...