Hans Rees' Sons, Inc. v. North Carolina Ex Rel. Maxwell
283 U.S. 123, 51 S. Ct. 385, 1931 U.S. LEXIS 133 (1931)
Rule of Law:
A state's statutory income tax apportionment method, even for a unitary business, violates the Fourteenth Amendment's Due Process Clause if its application attributes income to the state that is out of all appropriate proportion to the business transacted within that state.
Facts:
- Hans Rees’ Sons, Inc. (appellant) is a New York corporation engaged in tanning, manufacturing, and selling belting and other heavy leathers.
- Before 1923, the corporation established a manufacturing plant in Asheville, North Carolina, and dismantled all plants it had operated in other states.
- The business operates with both wholesale and retail plans; a warehouse and sales office are maintained in New York, where salesmen report and some finishing work is done.
- Approximately 40-50% of the output from the Asheville plant is shipped to the New York warehouse, with the remaining 60% shipped directly to customers based on orders from the New York office.
- The corporation's income was reportedly derived from three sources: buying profit (from skill in exploiting hide market fluctuations), manufacturing profit (from efficient tanning at its Asheville plant), and selling profit (from cutting and finishing leather for specific customer needs).
- Evidence offered by Hans Rees’ Sons, Inc. showed that for the years 1923, 1924, 1925, and 1926, the average income originating from its manufacturing and tanning operations within North Carolina was approximately 17% of its total income.
- During these years, North Carolina's Commissioner of Revenue, using a statutory apportionment method based on the fair cash value of real and tangible personal property within the state versus total property, allocated percentages ranging from 66% to 85% of Hans Rees’ Sons, Inc.'s income to North Carolina for tax purposes.
Procedural Posture:
- Hans Rees’ Sons, Inc. applied to the Commissioner of Revenue of North Carolina for a readjustment of its income tax assessment for the years 1923, 1924, 1925, and 1926.
- The Commissioner of Revenue made findings of fact and conclusions of law, which resulted in the appellant's exceptions being overruled and the prayer for tax revision being disallowed.
- Hans Rees’ Sons, Inc. appealed, waiving a jury, to the Superior Court of Buncombe County, North Carolina.
- The Superior Court struck out the testimony offered by the appellant as immaterial and held that the statute, as applied, did not violate constitutional rights, subsequently dismissing the action.
- The Supreme Court of North Carolina affirmed the judgment of the Superior Court, while also stating that, even if the evidence offered by the appellant were competent, it would not change the result.
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Issue:
Does a state's statutory income tax apportionment method, when applied to a multi-state unitary business, violate the Fourteenth Amendment's Due Process Clause if, based on factual evidence, it attributes income to the state that is out of all appropriate proportion to the business actually transacted within that state?
Opinions:
Majority - Chief Justice Hughes
Yes, a state's statutory income tax apportionment method, as applied to a multi-state unitary business, violates the Fourteenth Amendment's Due Process Clause if it attributes income to the state that is out of all appropriate proportion to the business transacted within that state. The Court rejected the state court's view that income from a 'single business enterprise' could not be split into independent sources for tax purposes, regardless of evidence. While recognizing that the enterprise of manufacturing and selling a product is typically a unitary business, the Court clarified that this does not permit an entire net income to be taxed by one state without regard to income derived from activities in other states. The Court distinguished prior cases, such as Underwood Typewriter Co. v. Chamberlain and Bass, Ratcliff & Gretton, Ltd. v. State Tax Commission, by highlighting that those cases lacked proof that the apportionment methods produced an unreasonable result. In contrast, Hans Rees’ Sons, Inc. presented compelling evidence demonstrating a gross disparity: its North Carolina-based operations contributed approximately 17% of its income, while the state's apportionment method allocated 66-85% of its total income to North Carolina. Such an extreme difference constituted an 'unreasonable and arbitrary' application of the statute, leading to the taxation of profits not justly attributable to transactions within North Carolina. Therefore, the taxes as applied were beyond the State's constitutional authority.
Analysis:
This case is a landmark decision affirming the constitutional limitations on state taxation of multi-state corporations, particularly under the Fourteenth Amendment's Due Process Clause. It establishes that even a facially valid apportionment formula can be unconstitutional if its practical application results in an 'unreasonable and arbitrary' allocation of income that is 'out of all appropriate proportion' to the business activities within the taxing state. This ruling provides a critical avenue for taxpayers to challenge state apportionment schemes by presenting specific evidence of economic distortion, thereby safeguarding against extraterritorial taxation and ensuring that state taxation bears a rational relationship to in-state income-generating activities. It significantly influenced the development of unitary business principles and apportionment methodologies.
