Costco Wholesale Corp. v. Dept. of Rev.

No. 59 July 16, 2012 537
IN THE OREGON TAX COURT
REGULAR DIVISION
COSTCO WHOLESALE CORP.
and Subsidiaries,
Plaintiff,
v.
DEPARTMENT OF REVENUE,
Defendant.
(TC 4956)
Plaintiff (taxpayer) appealed Defendant (the department)’s notices of defi-
ciency assessment and its decision to include income of taxpayer’s insurance com-
pany subsidiary in its calculation of taxpayer’s Oregon taxable income, arguing
that the income of the insurance company would not be in the tax base of its
Oregon consolidated return, but would be, if at all, subject only to taxation in
a separate return that might be required under ORS 317.710(7). Granting the
department’s motion and denying taxpayer’s motion, the court ruled that accord-
ing to the parties stipulations for the purpose of the motions, the insurance com-
pany was unitary with taxpayer, that no separate return was contemplated, and
that the department was only taking into account the income of a unitary affil-
iate in computing on an apportioned basis, the tax liability of a corporation over
which Oregon had jurisdiction to tax.
Oral argument on cross-motions for partial summary
judgment was held February 28, 2012, in the courtroom of
the Oregon Tax Court, Salem.
Theodore R. Bots, Baker & McKenzie, Chicago, filed the
motion and argued the cause for Plaintiff (taxpayer) pro se.
Marilyn J. Harbur, Senior Assistant Attorney General,
Department of Justice, Salem, filed the cross-motion and
argued the cause for Defendant (the department).
Decision for Defendant rendered July 16, 2012.
HENRY C. BREITHAUPT, Judge.
I. INTRODUCTION
This matter is before the court on cross-motions
for partial summary judgment. Plaintiff (taxpayer) and
Defendant (the department) have established all relevant
facts by stipulation. Those facts are as follows:
538 Costco Wholesale Corp. v. Dept. of Rev.
II. FACTS
The tax years at issue are the tax years ended on
August 31, 2003; August 31, 2004; August 28, 2005 and
September 3, 2006. Taxpayer is a Washington state corpo-
ration headquartered in Issaquah, Washington. Taxpayer is
engaged in the operation of membership warehouses offer-
ing branded and private label products in a range of mer-
chandise categories in no-frills, self-service warehouse facil-
ities throughout the United States, including warehouses in
Oregon.
Taxpayer is the parent corporation of a federal affil-
iated group comprised of Costco, NW Re Ltd. (the insurance
company) and other domestic corporations. Taxpayer filed
federal consolidated income tax returns on behalf of the
affiliated group for each of the tax years at issue. Taxpayer
filed Oregon consolidated corporation excise tax returns on
behalf of itself and its subsidiaries for each of the tax years
at issue.
In calculating the Oregon taxable income for each of
the years at issue for taxpayer and its subsidiaries, taxpayer
subtracted the insurance company’s income from taxpayer’s
affiliated group’s federal taxable income. The department
conducted an Oregon corporation excise tax audit of tax-
payer and its subsidiaries covering the tax years at issue.
As a result of the audit, the department proposed certain
adjustments to the Oregon returns as originally filed by tax-
payer and its subsidiaries.
The department issued notices of deficiency assess-
ment (Notices of Assessment), each dated June 23, 2009,
for the tax years at issue. In the Notices of Assessment, the
department asserted that taxpayer was liable for additional
tax, plus interest and penalties for each of the tax years at
issue. In the Notices of Assessment, among other adjust-
ments, the department determined that the insurance com-
pany was unitary with taxpayer and that the insurance
company’s income should be included with the Oregon tax-
able income of taxpayer and its subsidiaries.
Solely for the purpose of the parties’ cross-motions
for partial summary judgment on the legal question of
Cite as 20 OTR 537 (2012) 539
whether the department properly included the insurance
company and its taxable income in the Oregon consoli-
dated returns filed by taxpayer and its subsidiaries during
the years at issue, it is assumed that the insurance com-
pany was unitary with taxpayer and its subsidiaries and
that the insurance company was not required to file a sep-
arate Oregon corporate excise tax return pursuant to ORS
317.650.
The insurance company is a wholly owned subsidi-
ary of taxpayer. During the tax years at issue, the insurance
company was a Bermuda entity that elected to be treated
as a domestic corporation for federal income tax purposes
pursuant to Internal Revenue Code (IRC) section 953(d).
The insurance company insures general liability, workers
compensation, and automobile liability risks of taxpayer’s
affiliated group, including taxpayer.
The insurance company receives insurance premi-
ums from taxpayer’s affiliated group including taxpayer.
Through the Green Island Reinsurance Pool, the insurance
company also receives reinsurance premiums from unre-
lated third parties. During the tax years at issue, the insur-
ance company did not own or rent any property located in
Oregon. Nor did the insurance company have any employees
located in Oregon. The insurance company was not regis-
tered to do business in Oregon during the tax years at issue.
The insurance company did not file Oregon corporation
excise tax returns for any of the tax years at issue.
III. ISSUE
The issue presented at this stage of the case is
whether the income of the insurance company is to be
included in the calculation of the Oregon taxable income of
taxpayer.
IV. ANALYSIS
Of the foregoing facts stipulated for purposes of
these motions, two are of particular importance. The first
of those is that taxpayer and the insurance company are,
under Oregon tax law, in a unitary relationship with each
other. The second of those is that the insurance company is
540 Costco Wholesale Corp. v. Dept. of Rev.
not subject to taxation in Oregon and is not required to file
a return pursuant to the provisions of ORS 317.650 to ORS
317.665.1
The resolution of this case then depends on whether,
under the provisions of chapter 317 of the Oregon Revised
Statutes (chapter 317) the return of taxpayer must include
the income of the insurance company in the computation of
the Oregon taxable income of taxpayer. The parties have
agreed that the issue of apportionment factors, if that ques-
tion remains relevant, is to be considered in a later stage of
this litigation. In the resolution of the issue in these motions,
a discussion of the historical development of certain Oregon
statutes may be helpful.
The provisions of chapter 317 relating to returns
by companies—such as taxpayer, the insurance company
and their affiliates—filing federal consolidated returns
have been a feature of Oregon law since the mid 1980s. See
US West, Inc. and Subsidiaries v. Department of Revenue,
20 OTR 342, (2011). The purpose of those provisions was
to modify the theretofore existing system of worldwide com-
bined reporting that Oregon had developed. That system
had companies present in Oregon that had unitary rela-
tionships with other companies file combined reports. Those
combined reports included, in the calculation of the base for
taxation, the income of all companies, worldwide, that were
in the unitary relationship.
That system drew significant opposition from tax-
payers and foreign governments because it took into account
the income of foreign parent companies and subsidiaries in
calculating Oregon taxable income of members of the world-
wide group doing business in Oregon. Even though the
effects of combination of income of all unitary affiliates often
increased the tax base significantly, this was offset by includ-
ing, in the apportionment factor denominators, the factor val-
ues for all of the unitary affiliates as well. Nonetheless, for-
eign governments and their domestic corporations objected
1
All references to the Oregon Revised Statutes (ORS) are to 2003. Neither
party suggests that any material changes in the statutes occurred that would
alter the analysis for the later years in this case.
Cite as 20 OTR 537 (2012) 541
to the worldwide combination approach as it exposed foreign
companies to burdensome and costly audit procedures.
In 1984 Oregon responded to these objections
by adopting a “waters-edge” system. The “waters-edge”
approach was one in which the income of foreign parent or
subsidiary companies was not included in the calculation of
Oregon tax base for a related company doing business in
Oregon. This result was technically accomplished by using,
as a starting point for the calculation of companies filing
in Oregon, only the federal consolidated income of groups
that included companies doing business in Oregon. Because
federal consolidated returns may only include the income of
companies incorporated in one of the states of the United
States, the choice of that starting point for determination of
tax base meant that the starting number for calculation of
the tax base would not include the income of parent or sub-
sidiary companies incorporated in foreign countries.2
That said, Oregon did not otherwise abandon its
historical commitment to the determination of the income
tax base of Oregon taxpayers by use of the apportionment
of the combined income of all companies that were, within
the United States, in a unitary relationship. That is obvious
from the definition of a “unitary group” and a “single trade
or business” in ORS 317.705. As in the past, determinations
of income were to occur for each unitary group—that is each
group of companies engaged in a single trade or business.
For purposes of these motions both parties have accepted
the assumption that taxpayer and all of its subsidiaries—
including the insurance company—comprise one unitary
group.
Because the federal consolidated return statutes
and regulations do not take into account the concept of a uni-
tary group, ORS 317.715 provides a set of rules for the sep-
arate determination of the income of each unitary group in
cases where more than one unitary group exists within one
federal group of affiliated companies filing a consolidated
2
Under Internal Revenue Code (IRC) section 1504(d) certain contiguous
country corporations may also be included in a consolidated federal tax return.
542 Costco Wholesale Corp. v. Dept. of Rev.
return.3 Although the income of each unitary group is sep-
arately determined, there is in ORS 317.715 no provision or
indication that would permit the total income of all unitary
groups found within one federal consolidated return to be
less than the consolidated federal taxable income found on
the federal tax return.4
As to the one unitary group of companies assumed
to exist in this case and found within the federal consoli-
dated return, it is important to determine which company
has (or which companies have) by reason of sufficient con-
tact with Oregon, an obligation to file a return in Oregon.
If there is only one such company, the tax liability of the
company is based on the “modified federal consolidated
taxable income” for the unitary group to which that com-
pany belongs. In cases where there are two or more uni-
tary groups existing within one federal affiliated group, the
“modified federal consolidated taxable income” for the group
to which the company doing business in Oregon belongs is
determined under ORS 317.715(2). That amount is then sub-
ject to modifications specified by Oregon law and apportion-
ment or allocation under Oregon law.
For these motions, it is assumed there is only one
unitary group existing within the federal affiliated group
of corporations. That unitary group includes taxpayer,
the insurance company and all of their federal affiliates.
Accordingly, the starting point for the determination of the
Oregon taxable income of taxpayer is the entire consolidated
federal taxable income for the year in question. This amount
includes the income of the insurance company—it was, after
all, included in the federal consolidated return. The question
becomes whether other provisions of Oregon law require or
permit the exclusion of the income of the insurance company
3
ORS 317.715(2) begins with a statement indicating that it only addresses
situations where more than one unitary group exists. It appears to be possible
for an affiliated group to have one unitary group composed of multiple corpora-
tions and a second unitary group to be composed of only one corporation. ORS
317.705(2) defines a unitary group as being “a corporation or group of corpora-
tions,” and the concept of a single corporation unitary group is reflected in the
last clause of ORS 317.715(2).
4
It is possible that other provisions of Oregon law would cause additions,
subtractions or modifications to the consolidated federal taxable income amount.
Cite as 20 OTR 537 (2012) 543
from the starting point amount for taxpayer defined in
ORS 317.715. Nothing in ORS 317.715 provides for any such
exclusion.
The parties have discussed the extent, if any, to
which the provisions of ORS 317.710 may be relevant to the
question of the exclusion of the insurance company income.
To those provisions the court will now turn.
The starting point in ORS 317.710 is refreshingly
simple: if a corporation files a separate federal return, it will
file a separate Oregon return. ORS 317.710(3). If the corpo-
ration is included in a federal consolidated return, it will file
an Oregon consolidated return. ORS 317.710(2).
If, within any Oregon unitary group there is more
than one corporation having sufficient contact with Oregon
so as to create a filing requirement, ORS 317.710(5)(a)
dictates that all such corporations—that is corporations
“subject to taxation under this chapter,”—shall join in one
Oregon consolidated return. ORS 317.710(2) provides that
the liability of the corporations joining in such a return is
joint and several. The provisions of ORS 317.710 have, how-
ever, to do only with the requirement to file and the liability
for the tax due. They do not define the base of income subject
to taxation. Indeed, ORS 317.710(2) refers the reader to ORS
317.715 for determination of Oregon taxable income. The
provisions of ORS 317.710 therefore do not change the con-
clusion reached above regarding the inclusion of the insur-
ance company income in the starting number for calculation
of the base of income for taxpayer.
Important to this case is ORS 317.710(5)(b), which
reads:
“If any corporation that is a member of an affiliated group
is permitted or required to determine its Oregon taxable
income on a separate basis under ORS 314.670, or if any
corporation is permitted or required by statute or rule to
use different apportionment factors than a corporation with
which it is affiliated, the corporation shall not be included
in a consolidated state return under paragraph (a) of this
subsection.”
544 Costco Wholesale Corp. v. Dept. of Rev.
This provision can only be read as addressing corporations
over which Oregon has jurisdiction to tax. As to other cor-
porations it would be completely illogical to set forth what is
“permitted or required.”
As to corporations over which Oregon has juris-
diction, ORS 317.710(5)(b) dictates which corporations may
not be included in a return filed under subparagraph (5)(a),
even though they are in the same federal affiliated group
and the same Oregon unitary group. Stated differently,
subparagraph (5)(b) carves out of the Oregon consolidated
return contemplated by subparagraph (5)(a) these “special
apportionment” corporations.
Subparagraph (5)(b) does not carve the insur-
ance company or its income out of the unitary group whose
income has been determined under ORS 317.715. The reason
for this is that the subparagraph does not address compa-
nies, such as the insurance company, over which Oregon has
no jurisdiction.
There is one other set of provisions that taxpayer
asserts changes this conclusion. Those are the rules appli-
cable to foreign or alien insurers found in ORS 317.710(7).
ORS 317.710(7) requires the filing of a separate Oregon
return and determination of Oregon taxable income under
ORS 317.650 to ORS 317.665. The question becomes whether
this statutory provision applies to the insurance company,
a foreign or alien insurer. If ORS 317.710(7) applies to the
insurance company, its income would, by reason of the sepa-
rate return requirement found in the statute, not be includ-
able in the base of income used to calculate the Oregon lia-
bility of taxpayer.
The fact that the insurance company has insuffi-
cient contacts with Oregon to support jurisdiction once again
concludes the analysis. If Oregon does not have jurisdiction
to require the insurance company to file a return under ORS
317.650 to ORS 317.665, the provisions of ORS 317.710(7) can-
not and do not apply to the insurance company. Accordingly,
that statute does not provide for treatment of the income
of the insurance company in any fashion other than that
provided for in ORS 317.715. As stated above, under ORS
Cite as 20 OTR 537 (2012) 545
317.715 the income of the insurance company, being in the
federal consolidated income of the unitary group to which
taxpayer belongs, must be, after any adjustments otherwise
required by Oregon law, included in the Oregon tax base of
taxpayer subject to apportionment.
This conclusion is not inconsistent with the relevant
statutory or case law. As discussed above, the Oregon con-
solidated return provisions were designed to exclude from
Oregon unitary returns the tax items of corporations incor-
porated in foreign countries. That was a legislative choice
and not required of Oregon. The legislature did not go fur-
ther. The insurance company involved here is treated as a
United States corporation by election of taxpayer. Inclusion
of the income of the insurance company in the return cal-
culations for taxpayer does not therefore, conflict with the
purposes of the Oregon unitary tax rules.
Further, nothing in any of the statutory provisions
indicates that the legislature intended to exempt the income
of some insurance companies. Yet this is what the position
of taxpayer would produce. Under taxpayer’s construction
of the statutes, the income of the insurance company would
not be in the tax base of the Oregon consolidated return. It
would be, if at all, subject only to taxation in the separate
return that might be required under ORS 317.710(7). Yet, for
the reasons discussed, the parties have stipulated that, for
purposes of these motions, no separate return under ORS
317.650 to ORS 317.665 is required. It would follow then,
under taxpayer’s argument, that the income of the insur-
ance company would never be taken into account for Oregon
tax purposes, even though the company is in such a relation-
ship with taxpayer that they are considered to be in a single
trade or business. That is not the law of Oregon.
It bears observing that Oregon is, in no way, requir-
ing the insurance company to file a consolidated return or
asserting jurisdiction over it. Nor is Oregon directly imposing
a tax on the income of the insurance company. Those types
of arguments suggested by taxpayer have been rejected in
the past when made in challenges to the unitary method of
taxation. Oregon is only taking into account the income of a
unitary affiliate in computing, on an apportioned basis, the
546 Costco Wholesale Corp. v. Dept. of Rev.
tax liability of corporations over which Oregon has jurisdic-
tion to tax.
The conclusion in this opinion is also fully consis-
tent with the decision of this court in Dept. of Rev. v. Penn
Independent Corp., 15 OTR 68 (1999). Although the stat-
utory framework for taxation of insurance companies has
changed somewhat since the time of the law applicable in
Penn Independent Corporation, those changes are distinc-
tions without a substantive difference for purposes of the
question in this case. The fundamental holding of Penn
Independent Corporation was that the income of an insur-
ance company not subject to Oregon tax was includable in
the determination of the income of a unitary affiliate that
did have an obligation to compute income and pay tax to
Oregon under chapter 317.
V. CONCLUSION
Now, therefore,
IT IS ORDERED that Defendant’s Cross-Motion for
Partial Summary Judgment is granted; and
IT IS FURTHER ORDERED that Plaintiff’s Motion
for Partial Summary Judgment is denied.