W.R. Grace & Co.-Conn. v. Commissioner of Revenue (April 6, 2009)

COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD

W.R. GRACE & CO.- CONN.      v.     COMMISSIONER OF REVENUE (f/k/a W.R. GRACE & CO.)                

Docket No. C271787                  Promulgated:
							 April 6, 2009


	This is an appeal under the formal procedure pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the Commissioner of Revenue ("Commissioner" or "appellee") to abate corporate excises assessed against the appellant for the tax years ending December 31, 1992 and December 31, 1993 ("tax years at issue"). 
	Commissioner Scharaffa heard this appeal and was joined by Chairman Hammond and Commissioners Rose, Egan and Mulhern in the decision for the appellant. 
These Findings of Fact and Report are promulgated pursuant to a timely request by the appellee pursuant to G.L. c. 58A, § 13 and 831 CMR 1.32.

	Paul H. Frankel, Esq., Irwin M. Slomka, Esq. and Maxwell D. Solet, Esq. for the appellant. 

	Diane M. McCarron, Esq., John DeLosa, Esq. and Stephen G. Murphy, Esq. for the appellee. 



FINDINGS OF FACT AND REPORT
Based on a Stipulation of Facts and the testimony and exhibits offered into evidence at the hearing of this appeal, the Appellate Tax Board ("Board") made the following findings of fact.
At all times relevant to this appeal, the appellant, W.R. Grace & Co.- Conn. ("Grace") was a Connecticut corporation with its headquarters, commercial domicile, and principal place of business in Boca Raton, Florida.  Grace was engaged principally in a specialty chemical business conducted worldwide and throughout the United States, including Massachusetts.  Grace does not dispute that it had nexus with Massachusetts during the tax years at issue. 
Grace filed Massachusetts corporate excise returns for the tax years at issue.  On February 16, 1999, the Commissioner issued a Notice of Intention to Assess ("NIA") additional corporate excise against Grace for the tax years at issue.  On January 18, 2003, pursuant to consents to extend the deadlines for assessment, the Commissioner assessed corporate excises against Grace in the amount of $547,776 for the tax year ending December 31, 1992, and in the amount of $341,623 for tax year ending December 31, 1993, along with statutory interest and a penalty in the amount of $101,357 for the tax year ending December 31, 1992.  On April 15, 2003, Grace timely filed its abatement application seeking an abatement of the amounts assessed.  On September 9, 2003, the Commissioner issued a Notice of Abatement Determination denying Grace's request for abatement, and on October 30, 2003, Grace seasonably filed its Petition with the Board.  On the basis of the foregoing facts, the Board found and ruled that it had jurisdiction over this appeal.
The issues in this appeal are the taxability to Grace of an apportioned amount of the following: (1) a dividend in the form of a $700 million note received by Grace Cocoa Ventures, Inc. ("Ventures"), a Delaware corporation and subsidiary of Grace, in connection with "off-balance sheet" internal financing performed in preparation for an inter-company financing transaction among Grace and several of its subsidiaries and (2) interest income received directly and indirectly by Ventures on the $700 million note and indirectly on a subsequent $300 million note issued in connection with a third-party financing transaction.  The following details the receipt of the two promissory notes and their corresponding interest payments. 
Prior to December 30, 1992, Grace owned, through subsidiaries and other affiliated entities, 100% of Grace Cocoa Associates, LP ("Cocoa Associates"), a partnership engaged in the manufacture and processing of intermediate cocoa and chocolate products for sale as ingredients for the bakery, confectionary, dairy and beverage industries.  Cocoa Associates had its headquarters, commercial domicile and principal place of business in Stamford, Connecticut, and it had manufacturing operations in several states, including Massachusetts.  Cocoa Associates was included in Grace's Massachusetts combined corporation excise returns for the tax years at issue.
Grace also owned, first directly and then through a subsidiary, 100% of the stock of National Medical Care, Inc. ("NMC"), a corporation engaged in the dialysis and home health care business.  NMC's headquarters, commercial domicile and principal place of business were in Massachusetts.  NMC was included in Grace's Massachusetts combined corporation excise returns for the tax years at issue.
In 1992, Grace needed to obtain financing to pay off third-party creditors in order to improve its financial credit rating and thereby reduce its borrowing costs.  Financial lenders did not want to loan funds directly to Grace because of concerns regarding Grace's potential asbestos liabilities.  Therefore, in early 1992, a financing plan was presented to the Grace Board of Directors, with Grace's subsidiary, Cocoa Associates, proposed as the vehicle for obtaining $300 million in outside financing through another Grace affiliate, Tarpon Investors LP ("Tarpon").  This plan became known as the "Tarpon financing transaction."  The first step in the Tarpon financing transaction was to strengthen Cocoa Associates' balance sheet by having it acquire an interest-bearing note from an affiliate, to reduce Cocoa Associates' borrowing costs.  
In preparation for the Tarpon financing transaction, Grace formed two new Delaware corporations in April of 1992, Ventures and NMC Holding, Inc. ("Holding").  Both corporations had their headquarters, commercial domicile, and principal place of business in Boca Raton, Florida.  On May 14, 1992, through a series of capital contributions from Grace, NMC became a wholly-owned subsidiary of Holding, and Holding became a wholly-owned subsidiary of Ventures.  
On June 4, 1992, Holding declared a dividend to its sole shareholder, Ventures, in the form of a $700 million 15-year promissory note bearing an arm's-length rate of interest.  During the time that Ventures held the note, from June 4, 1992 through September 21, 1992, Ventures received $13,297,569 of interest income from Holding.  On September 22, 1992, Ventures contributed the $700 million note to a newly-formed Grace affiliate, Grace Cocoa Ventures LP ("Ventures LP"), a Delaware partnership, in exchange for a 99.99% general partnership interest (but a 100% share in profits and losses) in Ventures LP.  During the time that Ventures LP held the $700 million note, from September 22, 1992 through December 29, 1992, Ventures LP received $10,722,101 of interest income from Holding, all of which was included in Ventures' distributive share of Ventures LP's income.  
On December 30, 1992, Ventures LP contributed the $700 million note to Cocoa Associates in exchange for a 48.93% general partnership interest (but a 54%-59.85% share of profits and losses) in Cocoa Associates.  During the last two days of 1992, Cocoa Associates received $104,248 of interest income from Holding, $56,294 of which was included in Ventures' distributive share of Cocoa Associates' income.  The parties stipulated that on December 30, 1992, by virtue of acquiring a partnership interest in Cocoa Associates, Ventures acquired nexus with Massachusetts.  Although Holding paid interest on the $700 million note, it did not deduct any interest expense in Massachusetts on this note. 
The $700 million note and arm's-length interest gave Cocoa Associates the ability to pay a profit distribution to Tarpon, thus increasing Tarpon's capital in preparation for the Tarpon financing transaction.  On December 30, 1992, Tarpon received $285 million in loan proceeds from the Metropolitan Life Insurance Company and the Prudential Insurance Company ("Metropolitan and Prudential loans"), a $12 million capital contribution from outside investors in exchange for an 80% partnership interest in Tarpon, and a $3 million capital contribution from Grace Tarpon Investors, Inc., a Grace subsidiary, in exchange for a 20% partnership interest in Tarpon.  Tarpon took the total $300 million in funding and immediately contributed it to Cocoa Associates in exchange for a 20.97% limited partnership interest in Cocoa Associates, including a preferred share of Cocoa Associates' profits (46% in 1992 and 40.15% in 1993).  Cocoa Associates immediately loaned to Grace the $300 million it received from Tarpon in exchange for a $300 million promissory note bearing an arm's-length rate of interest.  Grace, in turn, paid interest to Cocoa Associates on the $300 million promissory note.  Ventures' share of this interest income received by Cocoa Associates was $7,531,648, $40,025 of which was received during the last two days of 1992, and $7,491,623 of which was received during 1993.  
As a result of the Tarpon financing transaction, Grace received $300 million in outside funding and incurred $300 million indebtedness to Cocoa Associates.  Cocoa Associates used the $700 note and the interest payments it received on the $700 million and $300 million notes to make preferred profit distributions to Tarpon, which Tarpon used to repay the Metropolitan and Prudential loans.
For the 1992 tax year, in computing the income of its combined group subject to Massachusetts tax, Grace excluded from Ventures' income the $700 million dividend and the $24,115,989 of interest income received directly and indirectly on the $700 million note and indirectly on the $300 million note.  For the 1993 tax year, Grace excluded $31,447,909 of interest income received indirectly by Ventures on both notes.  The Commissioner's auditor treated the disputed dividend and interest income as Ventures' apportionable business income and thus subject to tax.  The auditor apportioned the dividend and interest income based on the Massachusetts apportionment factors of Cocoa Associates.  The Commissioner assessed $547,776 for tax year 1992 and $341,623 for tax year 1993, plus interest and a $101,357.00 penalty for tax year 1992.  The parties stipulated that $661 of the tax liability from 1992 and $72,563 of the tax liability from 1993 represented Ventures' tax on its distributive share of income derived from Ventures LP, whose income consisted of its distributive share of income from Cocoa Associates, which was subject to Massachusetts tax.  Timothy Cremin, who served as the manager of state and local taxation for Grace during the tax years at issue, testified that Grace reported the interest on the $700 million and $300 million notes on its consolidated tax returns filed in Florida, the state of its commercial domicile.   
In analyzing whether the dividend and interest incomes were taxable, the first question to be addressed is whether Grace was engaged in a unitary business with the subsidiaries at issue, particularly Holding, NMC, Cocoa Associates and Ventures.  At the hearing, several witnesses offered testimony regarding the dealings between Grace and Cocoa Associates.  First, Donald H. Kohnken, the former executive vice president of the Grace specialty chemical division, testified that Grace "had no business dealings" with NMC, Holding, Ventures or Cocoa Associates.  He explained that there was no coordination of management, no joint use of office resources, marketing, advertising, corporate credit cards, or sales between and among Grace and these subsidiaries.  He testified that "the only commonality" was the occasional oversight of a financial officer, but that there were no other joint officers between the corporate entities.
Marc Lieberman, the director of taxes and assistant treasurer of NMC, corroborated Mr. Kohnken's testimony regarding the lack of unity among the Grace affiliates.  Mr. Lieberman stated that he had no familiarity with Cocoa Associates and that there were no meaningful intercompany activities, including the provision of goods or services, between and among NMC and Cocoa Associates.  He also testified that he had no knowledge of the details of the Tarpon financing transaction and that he had no reason to believe that the Tarpon financing transaction had any implications for NMC.  Gordon Chader, an assistant treasurer for Grace during the tax years at issue, confirmed that the purpose of the Tarpon financing transaction was to channel the money to Grace to reduce its debt.      
Finally, Brian Kenny, formerly the Chief Financial Officer of Cocoa Associates, testified that Cocoa Associates managed its own business operations separately from Grace.  He explained that Cocoa Associates was responsible for its own buying, pricing, and selling of ingredients and products.  He also explained that Cocoa Associates managed all of its treasury activities out of its Amsterdam operation and that it provided virtually no products or services to other Grace affiliates, aside from occasionally selling small amounts of chocolate at arm's-length prices for distribution to Grace's customers at Christmas time.  Mr. Kenny testified that Grace provided payroll services, some human resources training and information technology services to Cocoa Associates and that Cocoa Associates reported its financials and annual business plans to Grace.  However, he explained that Cocoa Associates' bank accounts were separate from those of Grace and that there was no joint purchasing with Grace.  
Mr. Kenny testified that late in 1991, as the result of a study it performed, Grace's board of directors decided that Cocoa Associates was not to be considered a core business, because its earnings were not competitive with those of the specialty chemical business.  Grace officially designated Cocoa Associates a non-core business in 1993.  This designation meant that Grace no longer reported Cocoa Associates' profits and losses together with those of the parent and that it was understood that Cocoa Associates would eventually be sold, which it was six years later.
Mr. Kenny also testified that the proceeds from the $300 million loan that Cocoa Associates received from Tarpon were immediately loaned to Grace and that Cocoa Associates had no expectation of retaining the funding from Tarpon for its own operations.  He explained:  "All along, this was clearly a transaction by which Grace was raising money for itself for its own purposes.  The purpose was to pay down outside debt so as to replace debt with minority interest on the balance sheet.  And this money was not being raised to help financially grow Cocoa [Associates]" which, Mr. Kenny emphasized, had been declared by Grace to be a discontinued operation.  Mr. Kenny further testified that Cocoa Associates had no expectation of using the interest income from either of the notes in its own operations and that it was strictly reserved for paying Tarpon on the $300 million note.  He explained that interest incomes paid by Holding and Grace on the $300 million and $700 million notes were used by Cocoa Associates solely to pay a profit distribution to Tarpon, which Tarpon used to repay the Metropolitan and Prudential loans.  The Commissioner did not cross-exam Mr. Kenny or produce any testimony or other evidence to rebut his testimony.
The Board also heard testimony from Richard Genetelli, CPA, whom the Board qualified as an expert in the field of accounting.  Mr. Genetelli prepared a financial analysis, which he characterized as reflecting "a very, very conservative point of view," meaning that, when in doubt, income was sourced to Massachusetts and deductions were not.  When analyzing Ventures' share of Cocoa Associates' Massachusetts income, Mr. Genetelli determined that the amounts properly subject to Massachusetts tax were $1,663,478 in 1992 and $2,075,757 in 1993, and the amounts that the Commissioner sought to tax were $6,987,900 in 1992 and $4,856,740 in 1993.  Mr. Genetelli concluded that the Commissioner was attempting to tax income that did not properly represent Ventures' in-state activities under principles of accounting.
On the basis of the foregoing subsidiary findings, the Board found that there was no coordination or integration between or among Grace and the subsidiaries at issue, namely Holding, NMC, Cocoa Associates and Ventures.  The businesses were each run by their own management teams.  There was no joint purchasing of materials or supplies; no shared use of offices or other facilities; no transfer of goods or services; and no transfer of personnel other than the occasional oversight in the financial area by a financial officer.  The Board deemed the oversight of this financial officer and the preparation of consolidated financial statements to be services in the nature of stewardship oversight which any parent would perform in connection with its investment in a subsidiary.  The Board thus found that there was no functional integration, no centralized management, and no economies of scale among the appellant and its subsidiaries.  Moreover, the facts found by the Board indicate that the incomes at issue were not derived from transactions that served an operational function, as opposed to an investment function.  Therefore, for the reasons stated more fully in the Opinion, the Board found that the transactions at issue were not part of a unitary business conducted by the appellant in Massachusetts. 
Having concluded that Ventures had taxable nexus with the Commonwealth by virtue of its partnership interest in Cocoa Associates, the Board next addressed whether the dividend and interest incomes had a sufficient connection with the in-state activities of Ventures.  The Board found credible the testimonies of Mr. Chader and Mr. Kenny, who both explained that neither Cocoa Associates nor any other Grace affiliate had use, or even the expectation of use, of the Tarpon financing funds, that this dividend and interest was used by Cocoa Associates solely to pay Tarpon so that it could pay the Metropolita1n and Prudential loans.  The Board found that the dividend and interest incomes were intended to be used, and were in fact used, to pay off third-party creditors in order to improve Grace's financial credit rating and thereby reduce its borrowing costs.  The Board thus found that the Commissioner was attempting to tax income that was not rationally related to Ventures' in-state activities.  
In contrast to the credible and persuasive evidence offered by Grace, the Commissioner offered no testimony or other evidence to support a finding that Grace, Cocoa Associates and Ventures were engaged in a unitary business.  Further, the Commissioner failed to cross examine or otherwise refute Grace's evidence on this issue.
Therefore, as will be explained in the Opinion, the Board concluded on this record that Grace has proven by clear and cogent evidence that the taxation at issue would lead to the taxation of extraterritorial values.  Accordingly, the Board issued a decision for the appellant in this appeal and granted an abatement in the amount of $816,175, along with all statutory additions except the $101,357 penalty for underpayment of estimated taxes.

OPINION
Every foreign corporation doing business in the Commonwealth is required to pay an excise based on its tangible property or its net worth, and its net income.  G.L. c. 63, § 39.  For the tax years at issue, the Massachusetts "gross income" of a corporation was generally equal to gross income as defined under the Internal Revenue Code ("Code"), as amended and in effect for the tax year, with some exceptions not relevant to this appeal.  G.L.   c. 63, § 30(3).  Massachusetts "net income" was equal to gross income minus all the deductions allowable under the Code, with several exceptions contained in G.L. c. 63, § 30(4).
The state's power to tax is not without limit.  The Commerce Clause and the Due Process Clause impose limitations on a state's power to tax out-of-state activities of an interstate enterprise.  The "broad inquiry" considered under both Constitutional clauses is "‛whether the taxing power exerted by the state bears fiscal relation to protection, opportunities and benefits given by the state,'" meaning, "‛whether the state has given anything for which it can ask return.'"  ASARCO Inc. v. Idaho Tax Comm'n, 458 U.S. 307, 315 (1982)(quoting Wisconsin v. J.C. Penney Co., 311 U.S. 435, 444 (1940)).
In this appeal, the appellant was required to demonstrate, by "clear and cogent evidence," that the Commonwealth sought to tax extraterritorial values.  Container Corp. of America v. Franchise Tax Bd., 463 U.S. 159, 175 (1983)(quoting Exxon Corp. v. Wisconsin Dept. of Revenue, 447 U.S. 207, 221 (1980)).   To meet this burden, the appellant must demonstrate "by clear and cogent evidence" that the taxing of the dividend and interest incomes at issue "is in fact 'out of all appropriate proportions to the business transacted . . . in [the Commonwealth],' [Hans Rees' Sons, Inc.,] 283 U.S., at 135, or has 'led to a grossly distorted result,' [Norfolk & Western R. Co. v. State Tax Comm'n, 390 U.S. 317,        326 (1968)]." Moorman Mfg. Co. v. Blair, 437 U.S. 267,   274 (1978).  Grace contended that the tax at issue reached extraterritorial values because (1) Grace was not engaged in a unitary business with the subsidiaries at issue, namely Holding, NMC, Ventures or Cocoa Associates, and (2) the income at issue lacked a sufficient connection with the in-state activities of Ventures and Cocoa Associates.

No unitary business was conducted between or among Grace and the subsidiaries at issue in this appeal, namely Holding, NMC, Ventures and Cocoa Associates.  

The entire amount of a corporation's net income is subject to the Massachusetts corporate excise if the corporation has no income from business activity which is taxable in another state.  G.L. c. 63, § 38(b).  If, as in the present appeal, the corporation has income from business activity which is taxable both in Massachusetts and elsewhere, its taxable net income is apportioned to Massachusetts by means of a three-factor formula based on the ratio of its Massachusetts property, payroll and sales to its property, payroll and sales everywhere.  G.L. c. 63, § 38(c)-(f).  "It has long been settled that 'the entire net income of a corporation, generated by interstate as well as intrastate activities, may be fairly apportioned among the States for tax purposes by formulas utilizing in-state aspects of interstate affairs.'"  Exxon Corp,      447 U.S. at 219 (citations omitted).  
The United States Constitution generally prohibits a state from taxing "extraterritorial values."  Container Corp., 463 U.S. at 164.  "A state may, however, tax an apportioned share of the value generated by the intrastate and extrastate activities of a multistate enterprise if those activities form part of a 'unitary business.'"  MeadWestvaco Corp. v. Illinois Dept. of Revenue, 553 U.S. __, 128 S.Ct. 1498, 1502 (2008); see generally Allied-Signal, Inc. v. Division of Taxation, 504 U.S. 768, 778-80 (1992).  The unitary business principle is the "linchpin" of a state's authority to consider out-of-state values in taxing a corporation for the privilege of conducting business in that state.  See generally Mobil Oil Corp. v. Comm'r of Taxes of Vt., 445 U.S. 425, 439 (1980).  As the Supreme Court explained in F.W. Woolworth Co. v. Taxation & Revenue Department of New Mexico, 458 U.S. 354 (1982), "if . . . 'factors of profitability' arising 'from the operation of the business as a whole' exist and evidence the operation of a unitary business, a State can gain a justification for its tax consideration of value that has no other connection with that State."  Id. at 364; accord W.R. Grace & Co. v. Commissioner of Revenue, 378 Mass. 577, 585 (1979).  
By contrast, a state transgresses clearly marked constitutional boundaries when it extends its taxing power to out-of-state business activities that are not part of a unitary business.  See Woolworth, 458 U.S. at 372.  The taxpayer has the burden of showing by "clear and cogent evidence" that the state tax results in extraterritorial values being taxed.  Exxon Corp., 447 U.S. at 221.  In the instant appeal, Grace contended that Massachusetts could not constitutionally tax the dividend and interest income at issue, because Ventures was not a member of a unitary business with Grace, Holding or Cocoa Associates, the payors of the dividend and interest income.     
Functional integration, centralization of management and economies of scale are indicia of a unitary business.  Container Corp., 463 U.S. at 179.  There is no single test for determining the existence of a unitary business; rather, there exists a wide range of constitutionally acceptable variations of the unitary business principle.  Id. at 167 ("A final point that needs to be made about the unitary business concept is that it is not, so to speak, unitary; there are variations on the theme, and any number of them are logically consistent with the underlying principles motivating the approach.").  The Supreme Court has emphasized that the proper inquiry looks to "the underlying unity or diversity of business enterprise," not simply to whether the non-domiciliary parent derives "some economic benefit -- as it virtually always will -- from its ownership of stock in another corporation."  Woolworth,  458 U.S. at 363-64. 
As this Board observed in an earlier appeal involving the appellant, W.R. Grace & Co.- Conn. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1999-622, 638, aff'd, 58 Mass. App. Ct. 469 (2003) ("Grace II"), "there are limits to the unitary business doctrine."  In Grace II, the Board paid specific heed to two key Supreme Court cases which shaped the unitary business doctrine, F.W. Woolworth Co. v. Taxation & Revenue Department,     458 U.S. 354 (1982) and ASARCO, Inc. v. Idaho State Tax Commission, 458 U.S. 307 (1982).  
Woolworth addressed whether the Due Process Clause permitted New Mexico, a non-domiciliary state, to tax the dividend income received by Woolworth from four foreign subsidiaries which did no business in New Mexico.  Woolworth, 458 U.S. at 356.  Woolworth wholly owned the three subsidiaries located in Germany, Canada and Mexico, and it owned a majority interest (52.7%) in the fourth, an English corporation.  Id. at 356-57.  The Court recognized that Woolworth's majority ownership entitled it to elect the subsidiaries' Boards of Directors and the potential to operate the subsidiaries as integrated divisions of a single unitary business.  Id. at 362.  However, "the potential to operate a company as part of the unitary business is not dispositive when, looking at 'the underlying economic realities of the unitary business,' the dividend income from the subsidiaries in fact is [derived] from unrelated business activity which constitutes        'a discrete business enterprise.'"  Id. at 363 (quoting Exxon Corp., 447 U.S. at 223-24).  The Court thus examined the facts to determine whether the subsidiaries and Woolworth enjoyed functional integration, centralization of management and economies of scale.  
Woolworth's subsidiaries performed many key functions independently of Woolworth, including advertising, site selection, merchandise selection and accounting.  Id. at 365.  Each subsidiary also retained its own outside counsel.  Id.  Moreover, Woolworth did not provide centralized purchasing, manufacturing or warehousing of merchandise, and Woolworth had no central personnel training programs.  Id. at 365-66.  The Court thus concluded that "the record is persuasive that Woolworth's operations were not functionally integrated with its subsidiaries."  Id. at 365-66. 
The Court next considered centralization of management and economies of scale.  The Court acknowledged some managerial links, including a vice president of Woolworth who served as liaison with the foreign subsidiaries, some common directors, and the communications between managers, including Woolworth's chief executive officer and other officers occasionally visiting the subsidiaries and the frequent mail, telephone, and teletype communications between the upper echelons of management.  Id. at 368-69.  Woolworth's published financial statements, including its annual reports, were prepared by the parent on a consolidated basis.  Id. at 369.  However, these links related to financial matters, including the payment of dividends and the creation of substantial debt, which had to be approved by Woolworth.  The Court referred to this as merely "the type of occasional oversight -- with respect to capital structure, major debt, and dividends -- that any parent gives to an investment in a subsidiary."  Id. at 369.  Yet more importantly, business decisions relating to day-to-day operations of the corporations remained autonomous.  Each subsidiary had its own full-time management, and, "[w]ith one possible exception," none of the officers was a current or former employee of Woolworth.  "The subsidiaries 'proceed . . . with their own programs, either formal or informal.  They develop their own managers and instruct them in their methods of operation.'" Id. at 367 (quoting testimony of record in F.W. Woolworth Co. v. Bureau of Revenue, 624 P.2d 51 (1979)).
In this respect, the Court distinguished Woolworth from Exxon, which addressed a single taxpayer corporation that was divided into three diverse and financially-segregated operations:  corporate management, coordination and service management, and operations.  In Exxon, the parent taxpayer retained significant control over the divisions through its Coordination and Services Management Office, which provided extensive services such as:
long-range planning for the company, maximization of overall company operations, development of financial policy and procedures, financing of corporate activities, maintenance of the accounting system, legal advice, public relations, labor relations, purchase and sale of raw crude oil and raw materials, and coordination between the refining and other operating functions "so as to obtain an optimum short range
operating program." 
 
Exxon, 447 U.S. at 211 (quoting Wisconsin Dep't of Revenue v. Exxon Corp., 281 N.W.2d 94, 97-113 (1979)).  The Exxon Court found that, because it provided such extensive oversight and services to its various departments, Exxon had not carried its burden of proving that the functionally separate departments were "discrete business enterprises" that did not benefit from "an umbrella of centralized management and controlled interaction."  Id. at 221.  
On the basis of the presented facts, and in contrast with the finding in Exxon, the Woolworth Court found that there was little centralization of management or economies of scale between Woolworth and its subsidiaries.  Woolworth, 458 U.S. at 364-66.  The Court thus ruled that, because the subsidiaries and parent did not benefit from functional integration, centralization of management or economies of scale, the four subsidiaries were not part of a unitary business with Woolworth.  Id. at 369.  Therefore, New Mexico's taxing of dividend income received from the subsidiaries failed to meet "established due process standards" and thus could not stand.  Id. at 372.  
In ASARCO, the Court examined whether Idaho, a non-domicilliary state, could constitutionally tax dividends received by a parent, which had nexus with Idaho, from five of its subsidiaries, which did not have nexus.  The "closest question" of the existence of a unitary business involved the subsidiary, Southern Peru, which produced "blister copper" and sold 35 percent of its output to the parent, ASARCO.  ASARCO, 458 U.S. at 321.  ASARCO employees were involved in the marketing of 20 to 30 percent of Southern Peru's output to European customers.  Id.  ASARCO also provided significant services for Southern Peru's operations outside of Peru, including purchasing service, traffic services for its imports and exports, and tax preparation services for its United States tax returns.  Id.  Moreover, "ASARCO's majority interest, if asserted, could enable it to control the management of Southern Peru."  Id.       
However, the ASARCO Court applied the principle that actual exercise of control, as distinguished from the legal right to control, is the sine qua non of the unitary business principle.  The Court first noted that, despite ASARCO's potential to control the management of Southern Peru, ASARCO had forgone the right to appoint officers and directors, and its subsidiary did not have any common directors or officers with the parent.  Id. at 322.  Second, while the parent held a controlling interest in the subsidiary, the remaining three subsidiary shareholders refused to allow the parent to dominate management of the subsidiary and so required the parent to enter a management agreement giving it the right to appoint fewer than a majority of directors -- six out of thirteen.  Id.  Finally, the subsidiary's bylaws required eight votes to pass any resolution, and its articles and bylaws could be changed only by unanimous consent of all four stockholders.  Id.  On the basis of its findings, the Court concluded that Southern Peru's business was autonomous and insufficiently connected with the parent for the subsidiary to be considered involved in a unitary business.  Id. 
The Board applied the principles from these Supreme Court cases in Grace II, which involved the sale by the taxpayer of its investments in its subsidiaries, Herman's, Channel/Central, and the Restaurant Group.  Grace II, Mass. ATB Findings of Fact and Reports at 1999-625.  The Board found that the businesses were all operated by their own management teams, with "no coordination or integration of the disputed businesses with the [a]ppellant's specialty chemicals business."  Id. at 634.  Furthermore, the Board found no joint purchasing of materials or supplies; no shared use of offices, warehouses, or other facilities; no joint training programs for employees or managers; no joint use of trademarks or trade names; no joint research, advertising, planning, engineering, or marketing; no shared technical expertise; and no transfers of personnel aside from "the occasional transfer in the financial area" of an employee familiar with a newly acquired operating system.  Id.  
The Board recognized that the taxpayer provided some supervision of the finances of its subsidiaries, but concluded that this was "more in the nature of a stewardship oversight function overseeing investments and one which any parent would give to an investment in a subsidiary."  Id.  See also General Mills, Inc. and Subsidiaries v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2001-474, 487, aff'd, 440 Mass. 154 (2003) ("Although General Mills provided its subsidiaries with some services, namely legal and tax, it was done primarily to assist General Mills in managing its investments.").  The Board thus concluded that there was no functional integration, centralized management, or economies of scale among the appellant and the subsidiaries at issue.  Grace II, Mass. ATB Findings of Fact and Reports at 1999-645.  Accordingly, even though the subsidiaries had nexus with Massachusetts, the Board concluded that, because no unitary business existed, "the taxation of gain from the sale of the subsidiaries in question would lead to the taxation of extraterritorial values in this case."  Id. at 1999-635. 
In determining whether a subsidiary is engaged in a unitary business with its parent, among the considerations deemed "noteworthy," is the "managerial role played by the [parent] in its subsidiaries' affairs."  Jacob Licht v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 1999-12, 24 (quoting Container Corp., 463 U.S. at 180, n. 19).  In this appeal, the appellant demonstrated that Grace did not exert control over the affairs of its subsidiaries, namely Holding, NMC, Ventures or Cocoa Associates, such that any of these entities should be classified as engaged in a unitary business with Grace or one another.  Grace and its subsidiaries did not engage in joint purchasing of materials or supplies; they did not share use of offices or other facilities; there were no transfers of goods or services; and there were no transfers of personnel other than the financial officer from Grace who provided occasional oversight to the subsidiaries.  The Board deemed the oversight of this financial officer and the preparation of consolidated financial statements to be services in the nature of stewardship oversight which any parent would give to an investment in a subsidiary.  
Based on the facts of record in this appeal, the Board found that there was no functional integration, centralized management, or economies of scale between or among Grace and the subsidiaries at issue.  The Board, therefore, found that the relationship between Grace and its subsidiaries did not satisfy the requirements for a unitary business and was instead more closely analogous to the corporate relationships in ASARCO and Woolworth.
Moreover, based on the facts found by the Board, the income at issue was not derived from transactions that served an operational function, as opposed to an investment function, in the business being conducted by Cocoa Associates or Ventures in Massachusetts.  See Allied-Signal, 504 U.S. at 787-89.  The appellant directed the Board's attention to a recent Supreme Court case, MeadWestvaco Corporation v. Illinois Department of Revenue, 553 U.S. __, 128 S.Ct. 1498 (2008), which confirmed that unitary business principles will determine whether a non-domiciliary state may apportion income from a business asset.  In that appeal, the Illinois trial court had found that there was no unitary business between the parent, Mead, and its division, Lexis.  Id. at 1504.  The Appellate Court of Illinois, however, had ruled that Illinois could nonetheless tax an apportioned share of Mead's capital gain realized on the sale of Lexis, even if it was not engaged in a unitary business with Lexis, because Lexis served an "operational purpose" in Mead's business, particularly the allocation of resources.  Id.   The Supreme Court rejected this argument, ruling that, pursuant to Due Process and Commerce Clause principles, as articulated in Container Corp., Allied-Signal and Mobil Oil, the taxation of extraterritorial values required a finding of a unitary business.  Id. at 1509.  It thus vacated the Appellate Court of Illinois' decision and remanded the case for a determination of whether a unitary business relationship existed between Mead and Lexis.  Id.
In the present appeal, the Commissioner contended that the transactions at issue served an operational function, as they arose as part of an overall operational strategy involving Grace and its subsidiaries.  The Commissioner cited the recent decision and findings in Sasol North America, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2007-942, contending that this appeal supported its arguments with respect to "the unitary concept, operational as opposed to investment functions, and sharing of values among business entities and segments."  In Sasol, the appellant, a domiciliary corporation which produced chemicals, became a limited partner in a Massachusetts limited partnership, Ampersand Specialty Materials and Chemicals II Limited Partnership ("ASMC-II LP").  In a memorandum, Sasol employee Brenda Myers of the Manufacturing Division explained the reasons why Sasol decided to purchase the ASMC-II LP limited partnership interest:  
Return aside, the major attraction of this investment to Vista is the opportunity to see approximately 300 new business proposals per year. Our past experience is that established companies sell for premium prices. [ASMC-II LP] provides the opportunity to screen a large number of new business opportunities at the ground floor and thus potentially to invest in a new business at a stage where significant return is possible.

Id. at 2007-948.  The Board thus found that its investment in ASMC-II LP "gave Sasol access to extensive inside information on developments in the specialty chemicals industry," and reflected "a corporate strategy of pursuing possible acquisitions in the specialty chemicals industry."  Id. at 2007-955.  As in Corn Products Co. v. Commissioner, 350 U.S. 46, 50-53 (1955), where the Supreme Court noted that the taxpayer's corn futures acquisitions were "vitally important to the company's business as a form of insurance against increases in the price of raw corn," Sasol's investment in ASMC-II LP served an operational function in the conduct of the taxpayer's business as opposed to a mere investment function, and therefore, the income in question arose from "business activity which is taxable both within and without this commonwealth" and thus subject to apportionment under G.L. c. 63, § 38(c).  Id. at 2007-971.   
Sasol, however, does little to support the Commissioner's position in this appeal.  Unlike the transaction at issue in that appeal, the transactions that yielded the dividend and interest incomes at issue in the instant appeal did not serve an operational function to the appellant, like the securing of raw materials for a business or the sharing of inside information for use in making decisions about possible acquisitions.  The Board thus found that Sasol was not relevant to the instant appeal and further found and ruled that the transactions at issue did not serve an operational function in the overall business of Cocoa Associates or Ventures.
Under the Due Process and Commerce Clauses, the existence of a unitary business relationship is required in order for a non-domiciliary state to tax the business income of a foreign corporation which is generated from intrastate and interstate activities.  Because there was no functional integration, centralized management, or economies of scale between and among Cocoa Associates, Ventures, Holding, NMC and Grace, and because the transactions at issue did not serve an operational as opposed to an investment function, the subject tax would lead to the taxation of extraterritorial values in contravention of the Due Process and Commerce Clauses.  See Exxon Corp., 447 U.S. at 221.  Accordingly, the Board found and ruled that the disputed portion of the Commissioner's assessment was improper.

II. The income at issue lacks a sufficient connection
    with the in-state activity of Ventures.

Grace also contended that the dividend and interest income at issue was not rationally related to Grace's Massachusetts activities, because neither Ventures nor Cocoa Associates had an expectation in or use of the disputed income for their in-state business activities, and therefore, the inclusion of the dividend and interest income in Grace's apportionable income resulted in the taxation of income out of all proportion to the business transacted by Ventures in the Commonwealth in violation of the Due Process Clause.  
Grace cited Mr. Genetelli's testimony that the Commissioner's assessment for 1992 was more than four times what would be subject to Massachusetts tax under his conservative financial analysis, and for 1993, it was more than two times.  Therefore, the appellant contended, the Commissioner was attempting to tax income that was not rationally related to Ventures' in-state activities.  See, e.g., In the Matter of British Land (Maryland), Inc. v. Tax Appeals Tribunal, 647 N.E.2d 1280, 1285 (N.Y. 1995) (striking down the application of state's taxing formula which resulted in a "marked discrepancy" when compared with a separate accounting).  Therefore, a tax on that income would "reach profits which are in no just sense attributable to transactions within [the taxing] jurisdiction" and accordingly would violate Due Process principles.  See Hans Rees' Sons, 283 U.S. at 134.
The Commissioner countered that Grace should be required to report the income at issue pursuant to G.L.   c. 63, §§ 38 and 39 and 830 CMR 63.39.1(8)(a), which require a partner to report its distributive share of partnership income.  The Commissioner cited as controlling authority two recent Board appeals, SAHI USA, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2006-794 and Utelcom, Inc. v. Commissioner of Revenue, Mass. ATB Findings of Fact and Reports 2005-9.  The Commissioner contended that pursuant to the aggregate theory of taxation, as articulated and applied in those cases, a partner is deemed to be conducting the partnership business directly and owning a share of the partnership's assets.    
The Board in Utelcom ruled that in G.L. c. 63, § 39, the statute addressing the Commonwealth's power to assess a tax on a corporation, the definition of "doing business" is "broad enough to include earning income from a limited partnership interest" when those earnings are derived from the entity's activities within the state.  Id. at 17 (citing International Harvester v. Wisconsin Dep't of Tax'n, 322 U.S. 435, 441-42 (1944) and Borden Chemicals and Plastics and L.P. v. Zehnder, 726 N.E.2d 73, 79 (Ill. App. Ct. 2000)).  The Board applied this principle in SAHI and found that by virtue of SAHI's ownership of a general and limited partnership interest in the partnership (MBG) which in turn was a partner in the partnership (OSA) that owned and operated the Meridien Hotel, SAHI was "doing business" in Massachusetts and therefore had nexus with Massachusetts.  SAHI, Mass. ATB Findings of Fact and Reports at 2006-805. 
After finding that nexus existed between the taxpayer and Massachusetts, the Board next looked to the source of the income at issue and determined that the income distributed to SAHI was derived from the operation of the Meridien Hotel in Massachusetts.  Id. at 2006-812.  Therefore, the Board found and ruled that the income was attributable to an activity conducted in Massachusetts and, accordingly, subject to the corporate excise.  Id. at 2006-814.
In the present appeal, however, Grace contended, and the Board found, that the incomes at issue were not related to the in-state activities of Ventures and Cocoa Associates.  Mr. Chader and Mr. Kenny both testified, and the Board found, that neither Cocoa Associates nor Ventures ever had an actual or expected use of the dividend or interest incomes for its in-state operations, because the entire transaction was undertaken for Grace to increase its capital.  Therefore, because the incomes at issue were not related to the in-state operations of Ventures or Cocoa Associates, the recipients, Utelcom and SAHI are not applicable to the present appeal.  Instead, in accordance with Due Process principles, as applied in ASARCO and Woolworth, the Commissioner is prohibited from assessing income which is not rationally related to the in-state activities of the recipient.  


Conclusion.
The dividend and interest incomes at issue in this appeal were generated as a result of the Tarpon financing transaction.  The Board first found and ruled that no functional integration, centralization of management, or economies of scale existed between or among Grace and the affiliates at issue in this appeal.  Moreover, on the basis of the facts found by the Board, the transactions at issue served an investment as opposed to an operational function in the business being conducted by Cocoa Associates and Ventures in Massachusetts.  Therefore, the Board found and ruled that Grace and the affiliates at issue in this appeal were not engaged in a unitary business with each other.  Accordingly, under Due Process and Commerce Clause principles, the incomes at issue were not subject to tax in Massachusetts.
The Board also found and ruled that that neither Cocoa Associates nor Ventures had an actual or expected use of the dividend or interest incomes for their in-state operations.  Therefore, the Board ruled that the assessments at issue violated Due Process principles as articulated in ASARCO and Woolworth.  

Accordingly, on the basis of these rulings, the Board ordered an abatement in the amount of $889,399, along with all statutory additions except the $101,357 penalty for underpayment of estimated taxes, which the Board found was proper. 



						THE APPELLATE TAX BOARD

				   By: ________________________________
					  Thomas W. Hammond, Jr., Chairman



A true copy,

Attest: ________________________________
   Clerk of the Board 

  As will be explained infra, Ventures received interest payments indirectly through its partnership interests in other Grace affiliates.  
  Grace received $285 million in Metropolitan and Prudential loans, $12 million in capital contributions from outside investors, and a $3 million capital contribution from Grace Tarpon Investors, Inc.
  As explained previously, the Commissioner assessed $547,776.00 for tax year 1992 and $341,623.00 for tax year 1993, plus interest, and a $101,357.00 penalty for tax year 1992.  The Board abated all but $661.00 of the tax liability for 1992 and all but $72,563.00 of the tax liability for 1993.  The parties stipulated that these amounts represented Ventures' distributive share of income derived from Ventures LP, whose income consisted of its distributive share of operational income from Cocoa Associates, which was subject to Massachusetts tax.  
 The Board ruled that the penalty was based on the amount of tax originally returned to the Commissioner and was therefore proper.
  Hans Rees' Sons v. North Carolina ex rel. Maxwell, 283 U.S. 123 (1931).
 There are exceptions to the three-factor formula which are not relevant under the facts of this appeal. See G.L. c. 63, § 38(k), (l) and (m). 
 "The hearing examiner found that '[in] the taxable year involved, none of the four [subsidiaries'] officers were currently or formerly employees of the parent.' Id., at 34a.  Without explanation, he also later stated that '[at] least one officer of the Canadian subsidiary [was] also an officer of the [parent].'"  Woolworth, 458 U.S. at 367, n. 15 (quoting from lower court record). 
  See Grace II, Mass. ATB Findings of Fact and Reports at 1999-628, 633.
 The Board found that, as testified to by Mr. Kenny, the occasional selling at fair market value of chocolate at Christmas time was arm's- length and therefore did not qualify for a transfer of goods which would constitute evidence of an economy of scale.

ATB 2009-261