Opinion
November 2, 1959 —
December 1, 1959.
APPEAL from two judgments of the circuit court for Dane county: RICHARD W. BARDWELL, Circuit Judge. Reversed.
For the appellant the cause was argued by E. Weston Wood, assistant attorney general, with whom on the brief were John W. Reynolds, attorney general, and Harold H. Persons, assistant attorney general.
For the respondent there was a brief by Frederic Sammond of Milwaukee, Henry N. Ess, Russell W. Baker, and Robert B. Olsen, all of Kansas City, Missouri, attorneys, and Fairchild, Foley Sammond of Milwaukee, and Watson, Ess, Marshall Enggas of Kansas City, Missouri, of counsel, and oral argument by Mr. Frederic Sammond and Mr. Baker.
Two actions by the Kansas City Star Company (hereinafter referred to as the "Star"), pursuant to the Wisconsin Administrative Procedure Act (ch. 227, Stats.), against the Wisconsin Department of Taxation (hereinafter referred to as the "department"), to review two orders of the Wisconsin board of tax appeals (hereinafter referred to as the "board"). One order relates to an assessment of additional corporate income taxes and the other to an assessment of additional privilege dividend taxes. The department also instituted two separate actions to review the same two orders in which the department sought to modify such orders so as to determine the amount of additional taxes in an amount greater than determined by the board. These various actions were consolidated for purposes of trial in the circuit court.
The Star is a Missouri corporation engaged in the publishing of newspapers in Kansas City. The taxes involved in these actions are for the years 1948, 1949, 1950, and 1951. During such four years the only business transacted in Wisconsin, which was subject to Wisconsin income and privilege dividend taxes, was the operation of a paper mill at Park Falls, Wisconsin. Such paper mill was not a separate corporate entity but constituted a division of the Star corporation. The controversy in the instant litigation revolves around the prices at which such paper-mill division transferred to the Star newsprint paper manufactured by such division. In order to bring such controversy into proper focus it is necessary to set forth a rather comprehensive resume of the facts.
Newsprint is a wood-pulp paper and there is only one grade of it. Unlike products such as wheat and corn it is not sold on a commodity market. The trade custom is for newspaper publishers, who purchase newsprint in quantities as large as carload lots, or larger, to enter into long-term contracts with the paper mills covering the publishers' requirements. Such contracts call for maximum and minimum tonnages over a period of five, ten, or fifteen years. Prices are not fixed by such contracts, but a pricing formula to protect the purchasers is included in such contracts. These pricing formulas are variously stated in different contracts but result in one common prevailing price. Some contracts merely provide that the contract price shall be such common prevailing price. Another method, illustrated by some of the contracts introduced in evidence in the instant cases, specifies that the price shall be the producer's "base announced price" or the average "base announced price" of two or three other named mills, whichever is lower. Thus the contract price fluctuates during the term of the contract as such common prevailing prices fluctuate. During a rising market, as was the case in 1948 to 195 1, such fluctuation was in but one direction and that was upward.
The term "base announced price" has reference to the fact that freight is included in the price and that prices vary in different zones. The zone system was originated by the International Paper Company in 1928, and has been followed in the newsprint trade ever since. Kansas City is in zone 4, and the zone 4 delivered prices are the "base" prices. To such base prices prescribed, additions or deductions are made in determining the common prevailing prices in the other zones. OPA adopted this pricing system when it established ceiling prices for newsprint in 1941.
The OPA regulations were lifted some time in 1946, and there was then a pent-up demand for newsprint which exceeded the supply. The situation had been aggravated by the fact that OPA pricing policies favored high-grade paper over newsprint with the result that during OPA controls paper-mill capacity of from 300,000 to 400,000 tons per annum had been permanently converted from newsprint to the making of high-grade paper.
For some years prior to 1947 the Star had depended for its source of supply of newsprint upon its long-term contract with the Minnesota Ontario Paper Company (hereinafter referred to as "M. O."). Under such contract, which was to expire at the end of 1946, the Star had the right to buy up to 55,000 tons of newsprint per year from M. O. Toward the end of 1946, M. O. notified the Star that in the future it would only be able to supply about 25,000 tons of newsprint per annum to the Star. This was because it had converted part of its capacity to making high-grade paper for Look magazine. Through negotiations the best the Star was able to do was to secure a new long-term M. O. contract commencing January 1, 1947, for 30,000 tons of newsprint. The Star then found itself in the worst position of any newspaper publisher of comparable size in the nation in so far as being able to purchase its requirements of newsprint. This was because all regular sources of supply had been already contracted for by others. Evidence of its need for newsprint over and above the 30,000 tons contracted from M. O. is disclosed by the fact that it actually used 57,451 tons in 1947, and 62,078 tons in 1948.
In an effort to secure newsprint, it purchased, effective January 1, 1947, all of the capital stock of the Flambeau Paper Company which for many years had operated a paper mill at Park Falls, Wisconsin. Prior to 1935 this mill had produced newsprint, but had gradually changed over into making high-grade paper. No newsprint had been made by such mill from early in the 1940's until the company was taken over by the Star. The Star at first continued the separate corporate existence of the company, but on August 25, 1947, dissolved it. Thereafter, the Flambeau mill has been operated as a division of the Star corporation. Such division will hereinafter be referred to as "Flambeau." No change was made in the accounting or cost systems and transfers of newsprint to the Star have been reflected as sales on Flambeau's books, the same as sales of its high-grade paper to other customers.
Only a portion of the Flambeau mill's production was diverted by the Star to newsprint. Based on dollar volume, about 63 per cent of total sales remained in high-grade paper sold to customers other than the Star during 1947 to 1948; in 1949 this went up to 85 or 86 per cent; and in 1950 it jumped to around 95 per cent. No newsprint was produced and sold to any customer other than the Star. The transfer prices reflected on the Flambeau books for the newsprint supplied to the Star were the prevailing base prices for newsprint being supplied under the afore-described long-term contracts in the industry. Flambeau's paper-making machines operated at a slow speed which was suitable for making high-grade paper, but not for newsprint. The result was that while high-grade paper was turned out by the mill at a good profit, the newsprint transferred to the Star was at a loss. The profit made on the high-grade paper was much greater than the loss sustained on the newsprint and very sizable payments of income tax were made by the Star to the state of Wisconsin to cover the four tax years in question.
About only 11,500 tons of paper were obtained by the Star from Flambeau in 1947 and approximately 16,000 tons in 1948. It also was successful in getting M. O. to supply an additional 15,000 tons in 1947 over and above the contract maximum quantity of 30,000 tons. Further negotiations were had with M. O. to secure additional tonnage for 1948 over and above the contract quantity, M. O. stated that it had commitments for supplying high-grade paper at a profit of $20 per ton greater than could be made from the production of newsprint, but, if the Star would reimburse M. O. for such loss of profit by paying $20 per ton over the prevailing base price for an additional 10,000 tons of newsprint for 1948, M. O. would supply such additional 10,000 tons. The Star had no alternative but to agree to this.
During the period of 1948 to 1951 involved in this litigation there existed a so-called "gray" market for newsprint at prices in excess of the prevailing base prices. The gray market in newsprint exists only at certain times of duress when mill capacities have not been able to keep up with demand. Only comparatively small quantities were available in such gray market because it was deemed unethical in the trade for paper mills to sell at prices above the prevailing base prices, and only a couple of marginal mills engaged in the practice. Another source of supply of gray market paper was Sweden. Less than two per cent of the total consumption of newsprint consumed in the United States during the period in question was sold at gray-market prices, and the remaining 98 plus per cent was sold at the prevailing base prices. The small extent of the gray market for such period appears from the following statistics:
Tons of newsprint Estimated tonnage consumed in U.S. in gray market ----------------- ----------------- 1948 5,140,806 110,000 1949 5,529,206 30,000 1950 5,936,941 45,000 1951 5,974,865 130,000 — — --------- ------- Totals 22,581,818 315,000Even after obtaining the additional 10,000 tons of newsprint from M. O. at a gray-market price of $20 above the prevailing base price and the 11,500 tons from Flambeau, it was necessary for the Star to go into the gray market in 1948 and purchase an additional 5,500 tons of newsprint from seven different sellers. of these 5,500 tons, 2,500 tons came from a single source in Sweden. While the prevailing base prices for newsprint for 1948 rose from $88.50 per ton on January 1st, to $101 on August 1st, the Star paid prices ranging from $171.01 to $211.06 for such purchases in the gray market.
However, in November, 1948, the Star entered into its first contract with Abitibi Sales Company, Ltd., of Canada (hereinafter referred to as "Abitibi"), for 6,000 tons of newsprint per year for eight years commencing January 1, 1949, at prevailing base prices. As the Abitibi mill got into production this contract was several times amended so as to increase the maximum quantity per year until finally by an amendment made in October, 1949, such quantity was raised to 20,000 tons per year.
In 1950, the Star together with several other newspapers purchased stock in the Coosa River Newsprint Company (hereinafter referred to as "Coosa River"). In addition to the stock owned by these newspapers, the Kimberly-Clark Corporation owned a minority interest and managed the enterprise. In 1950 and 1951 the Star purchased considerable quantities of newsprint from Coosa River at prevailing base prices.
During the four-year period of 1948 to 1951 the prevailing base price of newsprint was raised several times. As of January 1, 1948, such price was $95 per ton and by July 1, 1951, it had risen to $117 per ton and remained stationary for the balance of that year. The transfer prices charged the Star for newsprint supplied during such four-year period were at such prevailing base prices. Once there was a lag for several months in 1951 during which a new increase in the prevailing base price was not taken into account in such billing, but an adjusting entry was later made to charge the Star with such increase.
The following is a recapitulation of the Star's purchases of tons of newsprint in the four-year period of 1948 to 1951, together with the sources of supply:
Coosa Gray Year M. O. Flambeau Abitibi River Market Total ----------------------------------------------------------------- 1948 40,495 15,067 60 5,509 62,078 (Plus 947 (From 7 tons comic) dealers) 1949 33,998 5,465 18,367 5,114 62,944 (From 4 dealers) 1950 37,658 53 18,246 9,492 100 65,549 1951 32,645 2,711 19,217 10,927 2,804 68,574 (Plus 270 (From 5 tons pink) dealers) The department made a field audit of the Star's Wisconsin income-tax and privilege-dividend-tax returns for the four years in question. As a result of such audit the department issued a notice of an additional assessment of income taxes of $39,429.28 and of an additional assessment of privilege dividend taxes of $3,692.26. Such amounts of additional tax were based upon alleged additional income over and above that reported. Such additional income resulted from the department using theoretical transfer prices for the newsprint supplied by Flambeau to the Star, and disregarding the transfer prices reflected on Flambeau's books. Such theoretical transfer prices were obtained by using Flambeau's cost figures for producing such newsprint and adding thereto a profit figure of eight per cent. The Star made application to the department to abate such additional assessments, which applications were denied. The Star then timely petitioned the board for review of such determinations by the department.The board held a hearing in the matter at which testimony was presented and numerous exhibits were received in evidence. On January 4, 1957, the board entered its decisions and orders in both matters. The determination by the board was that there should be included in Flambeau's cost of producing newsprint certain items of sales and administration expense which Flambeau's newsprint-cost figures had not included, and which had not been taken into account by the department in establishing its theoretical newsprint-transfer prices. However, the board held that there should be excluded from such computation the eight per cent profit item. Such additional items of costs included by the board had been included by taxpayer in the total cost of all sales reported in the tax returns, but simply had not been allocated on Flambeau's books to the cost of producing newsprint.
On review in the circuit court it was determined that such newsprint-transfer prices should be computed on the basis of Flambeau's newsprint-cost figures before adjusted by the board, and without the eight per cent profit item added by the department. judgments to such effect were entered January 22, 1959, modifying the assessments in accord with such determination. From such judgments the department has appealed. The Star has also served a notice of review in which it seeks a review of the judgments in so far as they determine newsprint-transfer prices on a theoretical "fair value" basis.
Secs. 71.01 and 71.07(2), Stats., provide in part as follows:
"71.01 There shall be assessed . . . and paid a tax on all net income as hereafter provided . . . . by every nonresident of the state, upon such income as is derived from property located or business transacted within the state."
"71.07(2) Persons engaged in business within and without the state shall be taxed only on such income as is derived from business transacted and property located within the state.
The term "person" includes corporations. Sec. 71.02, Stats.
In a case of intracompany transfer across Wisconsin boundaries, the price attached to such transfer is crucial in determining the Wisconsin income subject to tax. There is no statute which specifically provides how such price is to be determined. We do have sec. 71.11(7) (a) which covers a situation where there are transfers made between subsidiary and parent corporations or affiliated corporations. Here we are not faced with a transfer between two different corporations but one occurring within a single entity.
". . . where a corporation, a substantial portion of whose capital stock is owned either directly or indirectly by another corporation, acquires and disposes of the products of the corporation so owning a substantial portion of its stock in such a manner as to create a loss or improper net income, the department may determine the amount of taxable income to such corporation for the calendar or fiscal year, having due regard to the reasonable profits which but for such arrangement or understanding might or could have been obtained from dealing in such products, goods, or commodities."
Such sec. 71.11(7) (a), Stats., was originally enacted as sec. 71.25 in 1925, after the intercorporate transfers had occurred which were the subject of the controversy before the court in Cliffs Chemical Co. v. Wisconsin Tax Comm. (1927), 193 Wis. 295, 302, 214 N.W. 447. The taxpayer in such case contended that this statute should not be applied retroactively. In partial answer to such argument the court stated, "The legislature, in passing the law, merely directed the tax commission to conform to a method which would have been their duty to adopt without the act."
We are satisfied that the same test of price of transfer is to be applied between intracorporation transfers, such as we have in the instant appeal, as in the case of intercorporation transfers governed by sec. 71.11(7) (a), Stats. Furthermore, there is no room for doubt but that such test is one of fair market value.
That fair market value is the proper test to apply is made clear by the opinion of this court in Standard Oil Co. v. Wisconsin Tax Comm. (1929), 197 Wis. 630, 223 N.W. 85. The plaintiff taxpayer was a foreign corporation doing business both within and without the state. Its Wisconsin business consisted of operating filling stations and maintaining storage tanks to supply its Wisconsin and Minnesota stations. The tax commission assessed the income tax due on the Wisconsin operations by apportionment of the company's total net income using a weighted ratio involving tangible property, cost of sales, and sales factors within and without the state. The position of the taxpayer in opposing such method of computing the tax is best stated by quoting from the court's opinion (p. 634):
"The plaintiff contends that its income should be ascertained by the allocation and separate accounting method by which the Wisconsin business is charged at the market price with all products received by it, with the expense of transacting the business, including a proper allocation of general or overhead expenses and office accounting; there should be credited to Wisconsin the gross amount received from sales of goods within the state, and that the difference constitutes the taxable income of the plaintiff company." (Emphasis supplied.)
This court sustained such contention of the taxpayer, thus putting its stamp of approval on valuing intracorporation transfers at market prices for purposes of income taxation.
The terms "market price," "market value," "fair value," "fair price," "fair market price," and "fair market value" are synonymous and interchangeable. These terms are generally interpreted to mean the price at which the goods would change hands between a seller willing but not compelled to sell, and a buyer willing but not compelled to buy. Estate of Gooding (1955), 269 Wis. 496, 502, 69 N.W.2d 586, and Estate of Ryerson (1941), 239 Wis. 120, 125, 300 N.W. 782. Both the taxpayer and the department agree as to the correctness of such definition but differ radically upon its application to the facts of this appeal.
The department contends that such test of fair market price must be applied to the peculiar situation in which the seller and buyer were placed at the time of transfer. From this premise it proceeds to argue that no seller of newsprint in the position of Flambeau, willing but not compelled to sell, would sell its product at a price less than cost plus a fair profit. One answer to this contention is that, if Flambeau had any choice in the matter, it would not have sold any newsprint because of its slow-speed machinery and resulting high cost of manufacture, but would have continued to make and sell high-quality paper at a good profit.
The test of fair market price is completely objective and has no reference to the peculiar position of the particular seller making the sale. We consider apposite the following statement appearing in Sloan v. Baird (1900), 162 N.Y. 327, 330, 56 N.E. 752, 753:
"The market value of property is established when other property of the same kind has been the subject of purchase or sale to so great an extent and in so many instances that the value becomes fixed."
Both the board of tax appeals and the circuit court declared in their memorandum decisions that the gray-market prices, which the Star paid for a portion of its newsprint during 1948 to 1951, were no criterion of fair market prices. This is because the Star was not in the position of a buyer willing but not compelled to buy; it was compelled to buy. The same is true of the $20 per ton bonus that the Star was compelled to pay to M. O. for the additional 10,000 tons supplied in 1948 over and above the contract quantity of 30,000 tons.
However, over 98 per cent of the newsprint consumed in the United States during 1948 to 1951 was sold at prevailing base prices. The undisputed testimony of an expert in the field, together with documentary evidence substantiating the same, established what such prevailing base prices were throughout such four-year period. While it is true that the newsprint so sold moved under long-term contracts, such contracts fixed quantities and not prices. The seller mills had it within their control to raise prices during the contract period in question.
Undoubtedly the mills were restrained from raising them further than they did by the fear that, if these prices were unreasonable, they might later end up losing their customers when the emergency was ended by new newsprint-producing mills entering the field. However, we do not believe this self-imposed restraint prevented the mills from being considered in the legal sense to be willing sellers at the prices which they received for their newsprint during this period. It is highly unlikely such prices thus fixed ex parte by the selling mills were lower than the mills believed that the purchasers would be willing to pay in a free and open market.
On the other hand, in one sense, the purchasers were not willing buyers not compelled to buy. This is because the shortage in the total supply of newsprint on the market compelled them to buy, irrespective of any provisions of their contracts specifying minimum tonnages. This factor is a most-persuasive argument as to why such prevailing base prices, under which more than 98 per cent of all newsprint in the nation was sold during 1948 to 1951, were not lower than fair market prices. However, where 98 per cent of a product moves at certain prices, most of it in arm's-length dealing, there would necessarily have to be a most unusual fact situation present to enable a court to declare that such prices were not fair market prices.
It is our considered judgment that such prevailing base prices must be held to be fair market prices. Inasmuch as the taxpayer used such prevailing base prices in pricing the transfers to itself of the newsprint supplied by Flambeau, there are no further income or privilege dividend taxes due, and the taxpayer's petitions to the department to abate the additional assessments here involved should have been granted.
By the Court. — The judgments are reversed with directions that the circuit court set aside the orders of the board and remand the proceedings to the board with directions to enter a proper order vacating the assessments of additional tax.
The taxpayer carries on a profitable newspaper publishing business. Its activities occur principally in Missouri, but in the years in question, it used raw materials which it had produced in Wisconsin. The problem is to allocate some portion of its net income to business transacted and property located within Wisconsin. The parties agree that the separate accounting method was to be used, and thus one of the determining factors in the allocation will be the "price" at which newsprint produced in Wisconsin and used in Missouri was reflected in the separate accounting. The principle relied upon by the majority is that if a Wisconsin operation be credited with the fair market value of the goods which a taxpayer produces here, but uses in another state, a fair allocation of the taxpayer's net income to business activity in Wisconsin will result. It seems clear, however, that in the situation before us, the use of the "prevailing" price does not produce a fair allocation. It results in too much income being allocated to the business in Missouri, and too little to the business in Wisconsin.
This is not to criticize the principle above referred to, but to state that the principle cannot be applied where the conditions of the market are such as described in this record. It appears that during the particular years those newsprint producers who wished to remain in that business and who sold newsprint upon the basis of the long-term contracts were willing to sell at the "prevailing" prices. There were other producers who were willing to do business on a short-run basis and not willing to give price consideration to customers in order to maintain the relationship during future years when supply might be in better balance with demand. These producers made sales at the so-called "gray market" prices, ranging much higher than the "prevailing" prices. Under the market conditions described, it seems to me to be impossible to determine a market price which would be useful in solving the problem before us. Evidently, a producer was a willing seller at the "prevailing" price if he wished to play the game on a long-term customer-relationship basis, but was not a willing seller at that price if he was not interested in the continuation of the business relationship. The transaction described in the majority opinion, where M. O. charged the Star a $20 per ton premium in 1948 for 10,000 tons, provides an illustration of a situation where a premium above prevailing price was necessary in order to induce a producer to sell where, as an alternative, he could have sold a different product to another customer on a more-profitable basis. If the Flambeau mill were not owned by the Star, it presumably would not have been selling newsprint to anyone because it would have produced more high-grade paper.
It appears that the Star chose to produce newsprint at its Wisconsin mill only under the impetus of the shortage conditions, and considered this of sufficient advantage to it under those conditions to warrant foregoing the opportunity of producing high-grade paper for profitable sale. It seems to me that this is a type of situation where too many fictions are involved in the application of the fair-market-value principle, and that the department adopted a method of allocation of the taxpayer's income to the Wisconsin operation which was not unreasonable.