WESTINGHOUSE ELECTRIC CORPORATION v. James H. TULLY, Jr., et al.

In this case, we are confronted with the question of the constitutionality of a franchise tax credit afforded by the State of New York to certain income of Domestic International Sales Corporations.

* The tax credit in issue was enacted as part of the New York Legislature's response to additions to and changes in the United States Internal Revenue Code of 1954 effectuated by the Revenue Act of 1971, Pub.L. 92-178, §§ 501-507, 85 Stat. 535. In an effort to "provide tax incentives for U.S. firms to increase their exports," H.R.Rep. No. 92-533, p. 9 (1971); S.Rep. No. 92-437, p. 12 (1971), U.S.Code Cong. & Admin.News 1971, p. 1825, Congress gave special recognition to a corporate entity it described as a "Domestic International Sales Corporation" or "DISC." §§ 991-997 of the Code, 26 U.S.C. §§ 991-997. A corporation qualifies as a DISC if substantially all its assets and gross receipts are export-related. §§ 992(a), 993.1 Under federal law, a DISC is not taxed on its income. § 991. Instead, a portion of the DISC's income—labeled "deemed distributions"—is attributed to the DISC's shareholders2 on a current basis, whether or not that portion is actually paid or distributed to them. § 995. Under the statutory provisions in effect during the calendar years 1972 and 1973 (the tax years in question in this case), 50% of a DISC's income was deemed distributed to its shareholders. 85 Stat. 544.3 Taxes on the remaining income of the DISC—labeled "accumulated DISC income"—are deferred until either that accumulated income is actually distributed to the shareholders or the DISC no longer qualifies for special tax treatment. § 996 of the Code, 26 U.S.C. § 996.

Enactment of the federal DISC legislation caused revenue officials in the State of New York some concern. New York does not generally impose its franchise tax on distributions received by a parent from a subsidiary; instead, the subsidiary is taxed directly to the extent it does business in the State. See N.Y. Tax Law § 208.9(a)(1) (McKinney 1966). Given the State's tax structure, had New York followed the federal lead in not taxing DISCs, a DISC's income would not have been taxed by the State. See New York State Division of the Budget, Report on A. 12108-A and S.10544, pp. 1, 5-6 (May 23, 1972), reprinted in Bill Jacket of 1972 N.Y.Laws, ch. 778, pp. 13, 17-18 (Budget Report). A budget analyst reported to the legislature that if no provision were made to tax DISCs, New York might suffer revenue losses of as much as $20-$30 million annually. Id., at 20. On the other hand, the analyst warned that state taxation of DISCs would discourage their formation in New York and also discourage the manufacture of export goods within the State. Id., at 18.4

With these conflicting considerations in mind, New York enacted legislation pertaining to the taxation of DISCs. 1972 N.Y.Laws, chs. 778 and 779 (McKinney), codified as N.Y. Tax Law §§ 208 to 219-a (McKinney Supp.1983-1984). The enacted provisions require the consolidation of the receipts, assets, expenses, and liabilities of the DISC with those of its parent. § 208.9(i)(B). The franchise tax is then assessed against the parent on the basis of the consolidated amounts. In an attempt to "provide a positive incentive for increased business activity in New York State," however, the legislature provided a "partially offsetting tax credit." Budget Report, at 18. The result of the credit is to lower the effective tax rate on the accumulated DISC income reflected in the consolidated return to 30% of the otherwise applicable franchise tax rate. The DISC credit, significantly, is limited to gross receipts from export products "shipped from a regular place of business of the taxpayer within [New York]." § 210.13(a)(2). The credit is computed by (1) dividing the gross receipts of the DISC derived from export property shipped from a regular place of business within New York by the DISC's total gross receipts derived from the sale of export property; (2) multiplying that quotient (the DISC's New York export ratio) by the parent's New York business allocation percentage;5 (3) multiplying that product by the New York tax rate applicable to the parent; (4) multiplying that product by 70%; and (5) multiplying that product by the parent's attributable share of the accumulated income of the DISC for the year. §§ 210.13(a)(2) to (5).

The basic facts are stipulated. Appellant Westinghouse Electric Corporation (Westinghouse) is a Pennsylvania corporation engaged in the manufacture and sale of electrical equipment, parts, and appliances. Westinghouse is qualified to do business in New York, and it regularly pays corporate income and franchise taxes to that State. Among Westinghouse's subsidiaries is Westinghouse Electric Export Corporation (Westinghouse Export), a Delaware corporation wholly owned by Westinghouse, that qualifies as a federally tax-exempt DISC. Westinghouse Export acts as a commission agent on behalf of both Westinghouse and Westinghouse's other affiliates for export sales of products manufactured in the United States and services related to those products. All of Westinghouse Export's income in 1972 and 1973 consisted of commissions on export sales. On both its 1972 and 1973 federal income and New York State franchise tax returns, Westinghouse included as income, and paid taxes on, an amount of deemed distributed income equal to about half of Westinghouse Export's income. In 1972, Westinghouse Export's income was about $26 million, and Westinghouse included in its consolidated return approximately $13 million of income deemed distributed from Westinghouse Export.6 In 1973, the income of Westinghouse Export was approximately $58 million; Westinghouse reported almost $30 million of that amount as deemed distributed income.7 Westinghouse, however, did not include the DISC's accumulated income in its consolidated returns.

The appellees, as the New York State Tax Commission (Tax Commission), sought to include in Westinghouse's consolidated income the accumulated DISC income; that is, the Tax Commission computed Westinghouse's taxable income by first combining all of Westinghouse Export's income with that of Westinghouse, pursuant to N.Y. Tax Law § 208.9(i)(B) (McKinney Supp.1983-1984). The Commission gave Westinghouse the benefit of the DISC export credit for the approximately 5% of Westinghouse Export's receipts each year that could be attributed to New York shipments.8 After applying the relevant allocation and tax percentages, the Tax Commission asserted deficiencies in Westinghouse's franchise tax of $73,970 (later corrected to $71,970) plus interest for 1972 and $151,437 plus interest for 1973. App. 42, 46.

Westinghouse filed a petition for redetermination of the proposed deficiencies. By its petition, as later perfected, Westinghouse contended that by requiring it to compute its franchise tax liability on a consolidated basis with Westinghouse Export, the Tax Commission was taxing income that did not have a jurisdictional nexus to the State, in violation of the Commerce and Due Process Clauses of the United States Constitution. Westinghouse further contended that limiting the tax benefit of the DISC export credit to gross receipts from shipments attributable to a New York place of business violated the Commerce, Due Process, and Equal Protection Clauses. The Commission declined to entertain Westinghouse's contentions, on the ground that, as an administrative agency, it lacked jurisdiction to pass upon "the constitutionality of the laws of the State of New York." Id., at 47.

Westinghouse then brought suit in the New York Supreme Court for review of the tax determination, again raising its constitutional claims. The case was transferred to the Appellate Division. That court, by a 3-to-2 vote, found the portion of the law that requires accumulated income of the DISC to be added to the consolidated return, § 208.9(i)(B), to be an unconstitutional burden on foreign commerce. 82 App.Div.2d 988, 440 N.Y.S.2d 397 (1981). The Appellate Division based its holding on the fact that Congress intended to exempt DISC income from current taxation. Id., at 989, 440 N.Y.S.2d, at 399-400. This decision made it unnecessary for the court to consider the constitutionality of New York's geographical limitation on the DISC export credit, because the credit applies only to accumulated DISC income. The Appellate Division, however, went on to reject Westinghouse's constitutional challenges to New York's taxation of deemed distributed income. Ibid., 440 N.Y.S.2d, at 400.

The Tax Commission took an appeal to the New York Court of Appeals from that portion of the Appellate Division's judgment invalidating § 208.9(i)(B), and Westinghouse cross-appealed from that portion of the judgment upholding the taxation of deemed distributions. Westinghouse again made the constitutional arguments it had raised below. In a unanimous opinion, the Court of Appeals reinstated the determination of the Tax Commission. 55 N.Y.2d 364, 449 N.Y.S.2d 677, 434 N.E.2d 1044 (1982). The Court of Appeals first held that Congress' decision not to tax DISCs at the federal level did not pre-empt a State from taxing a DISC. Id., at 372-373, 449 N.Y.S.2d, at 680-81, 434 N.E.2d, at 1047-1048. The court also rejected Westinghouse's argument that the State lacked the jurisdictional nexus necessary to satisfy the minimal due process standards on which the right to tax must be predicated. Finally, the court rejected Westinghouse's claim that the credit provided for in § 210.13(a) impermissibly subjected Westinghouse's export sales from a non-New York place of business to a higher tax rate than that on comparable sales shipped from a regular place of business in New York. The court noted that the credit was devised by the State to provide shareholders of DISCs with state-tax incentives akin to those enacted by Congress. The only difference was that, while Congress had chosen to provide the benefit in the form of a tax deferral, the New York Legislature had elected to use a credit. Id., at 374-376, 449 N.Y.S.2d, at 681-83, 434 N.E.2d, at 1049-1050.

The court acknowledged that the credit was intended to ensure that New York would not lose its competitive position vis-a-vis other States, since other States were also expected to offer tax benefits to DISCs. It traced the steps required in calculating the tax credit and concluded: "Obviously, the business allocation percentage plays an integral role in computing the tax credit." Id., at 375, 449 N.Y.S.2d, at 682, 434 N.E.2d, at 1050. Use of the business allocation percentage, the court reasoned, ensures that in taxing DISC income, the State is taxing only that DISC income that has a jurisdictional nexus with the State. The credit simply forgives a portion of the tax New York has a right to levy. Id., at 376, 449 N.Y.S.2d, at 683, 434 N.E.2d, at 1050. The portion of the tax to be forgiven is determined by reference to shipments of export property from a regular place of business in New York. The court was of the opinion that this method satisfies due process and that any effect on interstate commerce is too indirect to run afoul of the Commerce Clause. Ibid.

We noted probable jurisdiction only with respect to the question of the constitutionality of the DISC tax credit, 459 U.S. 1144, 103 S.Ct. 784, 74 L.Ed.2d 991 (1983), and we now reverse the judgment of the New York Court of Appeals in that respect.

The Tax Commission seeks to convince us that the DISC tax credit forgives merely a portion of the tax that New York has jurisdiction to levy. All the accumulated income of a DISC is attributed to its parent for tax purposes. Under unitary tax principles, however, if the parent has a regular place of business outside New York, the State will not actually tax the full amount of the accumulated income. Only a portion of the parent's net income (which includes the accumulated DISC income) will be subject to tax in New York. That portion is determined by reference to a business allocation percentage determined by averaging the percentages of in-state property, payroll, and receipts. See N.Y. Tax Law § 210.3 (McKinney Supp.1983-1984). This Court long has upheld, subject to certain restraints, the use of a formula-apportionment method to determine the percentage of a business' income taxable in a given jurisdiction. Container Corp. v. Franchise Tax Board, 463 U.S. 159, 169-171, 103 S.Ct. 2933, 2942-2943, 77 L.Ed.2d 545 (1983); see Illinois Central R. Co. v. Minnesota, 309 U.S. 157, 60 S.Ct. 419, 84 L.Ed. 670 (1940); Hans Rees' Sons, Inc. v. North Carolina ex rel. Maxwell, 283 U.S. 123, 51 S.Ct. 385, 75 L.Ed. 879 (1931); Bass, Ratcliff & Gretton, Ltd. v. State Tax Comm'n, 266 U.S. 271, 45 S.Ct. 82, 69 L.Ed. 282 (1924); Underwood Typewriter Co. v. Chamberlain, 254 U.S. 113, 41 S.Ct. 45, 65 L.Ed. 165 (1920).

The Tax Commission's argument that New York employs a constitutionally acceptable allocation formula, in our view, serves only to obscure the issue in this case. The acceptability of the allocation formula employed by the State of New York is not relevant to the question before us. The fact that New York is attempting to tax only a fairly apportioned percentage of a DISC's accumulated income does not insulate from constitutional challenge the State's method of allowing the DISC export credit. New York's apportionment procedure determines what portion of a business' income is within the jurisdiction of New York. Nothing about the apportionprocess releases the State from the constitutional restraints that limit the way in which it exercises its taxing power over the income within its jurisdiction.

Here, Westinghouse argues that the State of New York has sought to exercise its taxing power over accumulated DISC income in a manner that offends the Commerce Clause and the Equal Protection Clause of the Fourteenth Amendment. This challenge is not foreclosed by our holding that New York's allocation of DISC income is constitutionally acceptable. See 459 U.S. 1144, 103 S.Ct. 784, 74 L.Ed.2d 991 (1983) (dismissing for want of a substantial federal question Westinghouse's challenge to method of allocating DISC income to parent). "Fairly apportioned" and "nondiscriminatory" are not synonymous terms. It is to the question whether the method of allowing the credit is discriminatory in a manner that violates the Commerce Clause that we now turn.

The Tax Commission argues that multiplying the allowable credit by the New York export ratio of the DISC merely ensures that the State is not allowing a parent corporation to claim a tax credit with respect to DISC income that is not taxable by the State of New York. This argument ignores the fact that the percentage of the DISC's accumulated income that is subject to New York franchise tax is determined by the parent's business allocation percentage, not by the export ratio. In computing the allowable credit, the statute requires the parent to factor in its business allocation percentage. § 210.13(a). This procedure alleviates the State's fears that it will be overly generous with its tax credit, for once the adjustment of multiplying the allowable DISC export credit by the parent's business allocation percentage has been accomplished, the tax credit has been fairly apportioned to apply only to the amount of the accumulated DISC income taxable to New York. From the standpoint of fair apportionment of the credit, the additional adjustment of the credit to reflect the DISC's New York export ratio is both inaccurate and duplicative.

It is this second adjustment, made only to the credit and not to the base taxable income figure, that has the effect of treating differently parent corporations that are similarly situated in all respects except for the percentage of their DISCs' shipping activities conducted from New York. This adjustment has the effect of allowing a parent a greater tax credit on its accumulated DISC income as its subsidiary DISC moves a greater percentage of its shipping activities into the State of New York. Conversely, the adjustment decreases the tax credit allowed to the parent for a given amount of its DISC's shipping activity conducted from New York as the DISC increases its shipping activities in other States.9 Thus, not only does the New York tax scheme "provide a positive incentive for increased business activity in New York State," Budget Report, at 18, but also it penalizes increases in the DISC's shipping activities in other States.

In determining whether New York's method of allowing a DISC export credit violates the Commerce Clause, the foundation of our analysis is the basic principle that " '[t]he very purpose of the Commerce Clause was to create an area of free trade among the several States.' " Boston Stock Exchange v. State Tax Comm'n, 429 U.S. 318, 328, 97 S.Ct. 599, 606, 50 L.Ed.2d 514 (1977), quoting McLeod v. J.E. Dilworth Co., 322 U.S. 327, 330, 64 S.Ct. 1023, 1026, 88 L.Ed. 1304 (1944); accord, Great Atlantic & Pacific Tea Co. v. Cottrell, 424 U.S. 366, 96 S.Ct. 923, 47 L.Ed.2d 55 (1976). The undisputed corollary of that principle is that " 'the Commerce Clause was not merely an authorization to Congress to enact laws for the protection and encouragement of commerce among the States, but by its own force created an area of trade free from interference by the States. . . . [T]he Commerce Clause even without implementing legislation by Congress is a limitation upon the power of the States,' " including the States' power to tax. Boston Stock Exchange, 429 U.S., at 328, 97 S.Ct., at 606, quoting Freeman v. Hewit, 329 U.S. 249, 252, 67 S.Ct. 274, 276, 91 L.Ed. 265 (1946). For that reason, "[n]o State, consistent with the Commerce Clause, may 'impose a tax which discriminates against interstate commerce . . . by providing a direct commercial advantage to local business.' " Boston Stock Exchange, 429 U.S., at 329, 97 S.Ct., at 607, quoting Northwestern States Portland Cement Co. v. Minnesota, 358 U.S. 450, 458, 79 S.Ct. 357, 362, 3 L.Ed.2d 421 (1959). See also Halliburton Oil Well Cementing Co. v. Reily, 373 U.S. 64, 83 S.Ct. 1201, 10 L.Ed.2d 202 (1963); Nippert v. Richmond, 327 U.S. 416, 66 S.Ct. 586, 90 L.Ed. 760 (1946); I.M. Darnell & Son Co. v. Memphis, 208 U.S. 113, 28 S.Ct. 247, 52 L.Ed. 413 (1908); Guy v. Baltimore, 100 U.S. 434, 25 L.Ed. 743 (1880); Welton v. Missouri, 91 U.S. 275, 23 L.Ed. 347 (1876).

We have acknowledged that the delicate balancing of the national interest in free and open trade and a State's interest in exercising its taxing powers requires a case-by-case analysis and that such analysis has left " 'much room for controversy and confusion and little in the way of precise guides to the States in the exercise of their indispensable power of taxation.' " Boston Stock Exchange, 429 U.S., at 329, 97 S.Ct., at 606, quoting Northwestern States, 358 U.S., at 457, 79 S.Ct., at 362. In light of our decision in Boston Stock Exchange, however, we think that there is little room for such "controversy and confusion" in the present litigation. The lessons of that case, as explicated further in Maryland v. Louisiana, 451 U.S. 725, 101 S.Ct. 2114, 68 L.Ed.2d 576 (1981), are controlling.

In both Maryland v. Louisiana and Boston Stock Exchange, the Court struck down state tax statutes that encouraged the development of local industry by means of taxing measures that imposed greater burdens on economic activities taking place outside the State than were placed on similar activities within the State. In Maryland v. Louisiana, the Court held that Louisiana's "First-Use" tax—which imposed a tax on natural gas brought into the State while giving local users a series of exemptions and credits—violated the Commerce Clause because it "unquestionably discriminate[d] against interstate commerce in favor of local interests." 451 U.S., at 756, 101 S.Ct., at 2134. Similarly, in Boston Stock Exchange, the Court held unconstitutional a New York stock-transfer tax that reduced the tax payable by nonresidents when the tax involved an in-state (rather than an out-of-state) sale and applied a maximum limit to the tax payable on any in-state (but not out-of-state) sale. See 429 U.S., at 332, 97 S.Ct., at 608. The stock-transfer tax was declared unconstitutional because it violated the principle that "no State may discriminatorily tax the products manufactured or the business operations performed in any other State." Id., at 337, 97 S.Ct., at 610. The tax schemes rejected by this Court in both Maryland v. Louisiana and Boston Stock Exchange involved transactional taxes rather than taxes on general income. That distinction, however, is irrelevant to our analysis. The franchise tax is a tax on the income of a business from its aggregated business transactions. It cannot be that a State can circumvent the prohibition of the Commerce Clause against placing burdensome taxes on out-of-state transactions by burdening those transactions with a tax that is levied in the aggregate—as is the franchise tax rather than on individual transactions.

Nor is it relevant that New York discriminates against business carried on outside the State by disallowing a tax credit rather than by imposing a higher tax. The discriminatory economic effect of these two measures would be identical. New York allows a 70% credit against tax liability for all shipments made from within the State. This provision is indistinguishable from one that would apply to New York shipments a tax rate that is 30% of that applied to shipments from other States.10 We have declined to attach any constitutional significance to such formal distinctions that lack economic substance. See, e.g., Maryland v. Louisiana, 451 U.S., at 756, 101 S.Ct., at 2134 (tax scheme imposing tax at uniform rate on in-state and out-of-state sales held to be unconstitutional because discrimination against interstate commerce was "the necessary result of various tax credits and exclusions" that benefited only in-state consumers of gas).

The Tax Commission contends that the DISC export credit is a subsidy to American export business generally, and as such, is consistent with congressional intent in establishing DISCs and with the Commerce Clause. We find no merit in this argument. While the Federal Government may seek to increase domestic employment and improve our balance-of-payments by offering tax advantages to those who produce in the United States rather than abroad, a State may not encourage the development of local industry by means of taxing measures that "invite a multiplication of preferential trade areas" within the United States, in contravention of the Commerce Clause. Dean Milk Co. v. Madison, 340 U.S. 349, 356, 71 S.Ct. 295, 299, 95 L.Ed. 329 (1951). We note, also, that if the credit were truly intended to promote exports from the United States in general, there would be no reason to limit it to exports from within New York.

The Tax Commission argues that even if the tax is discriminatory, the burden it places on interstate commerce is not of constitutional significance. It points to the facts that New York is a State with a relatively high franchise tax and that the actual effect of the credit, when viewed in terms of the whole New York tax scheme, is slight. It argues that the credit was not intended to divert new activity into New York, but, rather, to prevent the loss of economic activity already in the State at the time the tax on accumulated DISC income was enacted. Whether the discriminatory tax diverts new business into the State or merely prevents current business from being diverted elsewhere, it is still a discriminatory tax that "forecloses tax-neutral decisions and . . . creates . . . an advantage" for firms operating in New York by placing "a discriminatory burden on commerce to its sister States." Boston Stock Exchange, 429 U.S., at 331, 97 S.Ct., at 608.11 The State has violated the prohibition in Boston Stock Exchange against using discriminatory state taxes to burden commerce in other States in an attempt to induce " 'business operations to be performed in the home State that could more efficiently be performed elsewhere,' " id., at 336, 97 S.Ct., at 610, quoting Pike v. Bruce Church, Inc., 397 U.S. 137, 145, 90 S.Ct. 844, 849, 25 L.Ed.2d 174 (1970), and to " 'impose an artificial rigidity on the economic pattern of the industry,' " id., at 146, 90 S.Ct., at 849, quoting Toomer v. Witsell, 334 U.S. 385, 404, 68 S.Ct. 1156, 1166, 92 L.Ed. 1460 (1948).12 When a tax, on its face, is designed to have discriminatory economic effects, the Court "need not know how unequal the Tax is before concluding that it unconstitutionally discriminates." Maryland v. Louisiana, 451 U.S., at 760, 101 S.Ct., at 2136.13

The manner in which New York allows corporations a tax credit on the accumulated income of their subsidiary DISCs discriminates against export shipping from other States, in violation of the Commerce Clause. The contrary judgment of the New York Court of Appeals is therefore reversed.

It is so ordered.