Genentech, Inc. v. Commissioner of Revenue , 476 Mass. 258 ( 2017 )

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SJC-12083
GENENTECH, INC. vs. COMMISSIONER OF REVENUE.
Suffolk. October 7, 2016. - January 12, 2017.
Present: Gants, C.J., Botsford, Lenk, Hines, Gaziano, Lowy, &
Budd, JJ.
Taxation, Corporate excise, Manufacturing corporation.
Constitutional Law, Taxation, Commerce clause, Interstate
commerce.
Appeal from a decision of the Appellate Tax Board.
The Supreme Judicial Court on its own initiative
transferred the case from the Appeals Court.
Catherine A. Battin, of Illinois (Richard C. Call also
present) for the taxpayer.
Brett M. Goldberg (Jamie E. Szal also present) for
Commissioner of Revenue.
BOTSFORD, J. Under the Massachusetts corporate excise tax
statute, G. L. c. 63, corporations that generate business income
in Massachusetts and other States pay taxes on that income
according to a statutory formula that seeks to apportion and tax
the corporation's income generated in the Commonwealth.
2
Beginning in 1996, for a "manufacturing corporation," the
apportionment formula has been based solely on the corporation's
sales, see G. L. c. 63, § 38 (l), inserted by St. 1995, c. 280,
§ 2. The taxpayer Genentech, Inc., is a Delaware corporation
with a principal place of business in California and earns
business income in the Commonwealth as well as other States. In
this appeal from a decision of the Appellate Tax Board (board),
Genentech challenges the board's determination that it qualified
as a manufacturing corporation for the tax years 1998 through
2004 (tax years at issue); it also challenges the board's
rejection of its claim that application of § 38 (l)'s single-
factor apportionment formula based on sales to the company
violated the commerce clause of the United States Constitution.
We affirm the decision of the board.
Facts. We summarize the findings of fact made by the
board. See G. L. c. 58A, § 13 ("The decision of the board shall
be final as to findings of fact"). Genentech is a biotechnology
company that develops drugs derived from proteins produced by
living cells. Through a four-step process, Genentech employees
modify the genetic codes of living cells to produce "proteins of
interest" with desired pharmacologic effects.1 First, Genentech
scientists and other employees alter the deoxyribonucleic acid
1
Genentech's four-step process transforms the living cells
into insulin, human growth hormone compounds, and a drug used
for cancer treatment.
3
(DNA) of the selected cells to instruct them to produce a
specific "protein of interest." Second, employees facilitate
the production of the protein of interest by placing the
genetically altered cells in successively larger tanks to enable
growth and feeding them glucose and other nutrients while
closely monitoring their environment. Third, the protein of
interest is purified by separating it from the mix of cells and
other material present through ultrafiltration and
chromatography; Genentech must extract the protein from some
cells by "disrupting" or breaking down the cell walls containing
them. Finally, following the purification process, Genentech
employees formulate the resulting bulk drug into its final
dosage form, and package it for sale to distributors or directly
to physicians, hospitals, and pharmacies around the world.
On the financial side of Genentech's operations, the
company invests excess cash in short-term securities -- money
market funds, commercial paper, and treasury bonds. From two to
seven employees working in Genentech's treasury department
conduct a daily assessment of Genentech's cash needs and then
liquidate short-term investments to free up cash or invest
excess cash in short-term securities, as necessary. Money
market funds are pooled investment vehicles that aim to maintain
a consistent net asset value of one dollar per share.
Consequently, investors generally expect to be able to redeem
4
their shares for the amount originally invested, while also
earning interest or dividends through the term that they hold
shares in the money market fund. During the tax years at issue,
the money market funds held in Genentech's accounts maintained a
one dollar net asset value, thus allowing Genentech to redeem
them for the purchase price.2
Genentech's receipts pertaining to the transactions
involving the short-term assets held in a number of Genentech's
separate accounts in Mellon Bank established there were no
capital gains or losses generated during the tax years at issue;3
Genentech thus was able to either redeem the securities in every
instance for the same amount as it paid for them, or hold the
securities to maturity. Genentech did not include the proceeds
it received from the redemption of its short-term securities in
the statement of its revenue for purposes of the company's
financial statements, in the computation of gross receipts
reported on its Federal corporate income tax return that was
2
The board defined commercial paper as "a short-term debt
instrument that is usually issued by a corporation in order to
meet working capital needs as an alternative to a bank loan."
The board did not further discuss commercial paper in its
decision, and did not discuss treasury bonds at all beyond
stating that they were a form of short-term security in which
Genentech placed funds.
3
Genentech maintained eleven accounts holding short-term
assets at Mellon Bank, and Mellon Bank was responsible for
keeping the records of all deposits, withdrawals, sales and
purchases of securities, redemptions, and receipt of interest
and dividends; Genentech did not keep its own records.
5
used to determine its taxable income, or in the total of its
receipts used to compute sales factor apportionment in filling
out the company's California excise tax returns.
Procedural history. For the tax years 1998 through 2003,
Genentech filed its Massachusetts corporate excise returns using
the three-factor apportionment formula based on property,
payroll, and sales that applies to most general business
corporations. See G. L. c. 63, § 38 (c).4 For the 2004 tax
year, Genentech originally filed its Massachusetts corporate
excise tax return using the single-factor apportionment formula
applicable to manufacturing corporations, but later filed an
application for abatement, claiming that it was not
substantially engaged in manufacturing and thus should have been
entitled to apportion its income on the standard three-factor
basis.
The commissioner of revenue (commissioner) issued four
notices of assessment to Genentech, taking the position that
4
As discussed infra, through 1995, G. L. c. 63, § 38,
applied the three-factor apportionment factor set out in § 38
(c) to manufacturing corporations. See G. L. c. 63, § 38, as
amended through St. 1988, c. 202. The 1995 amendment to § 38
added § 38 (k) and (l), which established different
apportionment formulas for "defense corporations" and
"manufacturing corporations," respectively, see St. 1995,
c. 280, § 2, and, as relevant to the tax years at issue in this
case, § 38 (l) was amended in 1996, see St. 1996, c. 151, § 209.
The formula for manufacturing corporations is a single-factor
formula based solely on the corporation's sales factor. See
G. L. c. 63, § 38 (l).
6
Genentech was engaged in substantial manufacturing activity for
all the tax years at issue and thus required to use the single-
factor apportionment formula in § 38 (l). Genentech filed
several applications for abatement, all of which the
commissioner denied. Genentech timely filed petitions under
formal procedure with the board for each denial. The board
ruled that Genentech was engaged in manufacturing for purposes
of § 38 (l), that its manufacturing activities were
"substantial[]," as required by § 38 (l), and that application
of the single-factor apportionment formula to the company did
not violate the commerce clause. Genentech filed a timely
appeal, and we transferred the case from the Appeals Court to
this court on our own motion.
Standard of review. "A decision by the board will not be
modified or reversed if the decision 'is based on both
substantial evidence and a correct application of the law.'"
Capital One Bank v. Commissioner of Revenue, 453 Mass. 1, 8,
cert. denied, 557 U.S. 919 (2009), quoting Boston Professional
Hockey Ass'n v. Commissioner of Revenue, 443 Mass. 276, 285
(2005). "Because the board is authorized to interpret and
administer the tax statutes, its decisions are entitled to
deference. . . . Ultimately, however, the interpretation of a
statute is a matter for the courts" (citation omitted). Onex
7
Communications Corp. v. Commissioner of Revenue, 457 Mass. 419,
424 (2010).
Discussion. 1. Genentech's manufacturing. During the tax
years at issue, a "manufacturing corporation" was defined in
§ 38 (l) (1) in relevant part as follows:
"In order to be engaged in manufacturing, the corporation
must be engaged, in substantial part, in transforming raw
or finished physical materials by hand or machinery, and
through human skill and knowledge, into a new product
possessing a new name, nature and adapted to a new use."5
This court has considered whether particular activities
conducted by a corporation qualify as "manufacturing" in a
number of different factual contexts.6 We start with the premise
that a critical component of manufacturing is "the implication
of change wrought through the application of forces directed by
the human mind, which results in the transformation of some
5
The regulations of the commissioner, 830 Code Mass. Regs.
§ 58.2.1(6)(b) (1999), further provide that the "facts and
circumstances of each case" will be examined with various
principles serving as guidelines; principle (2), which states
that "[i]f the process involves chemical change to property
rather than only physical change, it is more likely to be
manufacturing," is of particular relevance to this case.
6
The issue has arisen often in cases involving the
exemption from local property taxation for machinery of domestic
manufacturing corporations under G. L. c. 59, § 5, Sixteenth
(3). See, e.g., William F. Sullivan & Co. v. Commissioner of
Revenue, 413 Mass. 576 (1992); Southeastern Sand & Gravel, Inc.
v. Commissioner of Revenue, 384 Mass. 794 (1981); Franki Found.
Co. v. State Tax Comm'n, 361 Mass. 614 (1972). However, our
cases have considered the term "manufacturing corporation" to
have the same meaning in the property tax exemption statute as
it does in the corporate excise tax statute, G. L. c. 63. See,
e.g., William F. Sullivan & Co., supra at 576-577, 579-580.
8
preexisting substance or element into something different, with
a new name, nature or use." Boston & Me. R.R. v. Billerica, 262
Mass. 439, 444-445 (1928). See William F. Sullivan & Co. v.
Commissioner of Revenue, 413 Mass. 576, 579 (1992) ("our
decisions have embraced the basic concept of manufacturing
articulated in Boston & Me. R.R [supra]"); The Charles River
Breeding Labs., Inc. v. State Tax Comm'n, 374 Mass. 333, 335
(1978) ("Manufacturing normally involves a change of some
substance, element, or material into something new or
different").
In cases where this court has determined that a company's
activities did not qualify as manufacturing, we have noted the
absence of new products "of substantially different character"
(citation omitted). Tilcon-Warren Quarries, Inc. v.
Commissioner of Revenue, 392 Mass. 670, 673 (1984). In that
case, for example, we concluded that extracting rocks from the
ground and crushing them into smaller, commercially usable sizes
did not involve a change in the material's character necessary
to qualify as manufacturing. See id. at 672-673. Similarly,
the breeding and raising of partially uncontaminated laboratory
animals was determined not to be manufacturing because
"[m]anufacturing normally involves a change of some substance,
element, or material into something new or different [and] [n]o
matter how intricately it is carried on, the production of
9
partially uncontaminated animals by [the taxpayer] does not fit
within this definition" (citation omitted). The Charles River
Breeding Labs., Inc., 374 Mass. at 335.
On the other hand, we have found that a multitude of
activities fall under the definition of manufacturing. We have
held, for example, that a publisher's "compilation of
information, photographs, and text, into proofs, edited,
refined, and ultimately transferred to disk or CD ROM" is
manufacturing because "[t]he disks and CD ROMs possess a new
nature and are adapted for a new use, namely the printing and
binding of books." Commissioner of Revenue v. Houghton Mifflin
Co., 423 Mass. 42, 50-51 (1996). Similarly, the transformation
of raw green coffee beans into marketable coffee through
roasting, grinding, packaging, and selling is manufacturing,
given that "a raw material which was unfit for human consumption
or any other practical use" was converted into "a finished
product which differed substantially from the raw material in
appearance, form and taste, and which was thereby made adaptable
to a use for which it otherwise would not be available."
Assessors of Boston v. Commissioner of Corps. & Taxation, 323
Mass. 730, 741 (1949).
As in the cases just cited, we conclude that Genentech
engages in manufacturing for purposes of § 38. Genentech argues
its activities are comparable to mining. Unlike the extraction
10
and crushing of rocks in the Tilcon-Warren Quarries case,
however, Genentech is not merely paring something down to a
smaller size. See 392 Mass. at 673. Nor do the cells that
Genentech develops remain significantly unchanged. Rather,
Genentech scientists and other employees, by hand or machine,
implant DNA molecules into a cell to genetically transform the
medium to behave in ways other than what its natural genetic
code would dictate. Although the cells may replicate thereafter
on their own, each genetically modified and replicated cell is
different from the original cell in a most fundamental way.
Moreover, the modified cell itself is far from the final
product: it is the "protein of interest" that Genentech
extracts from each of the modified cells and then purifies that
serves as the source of each drug that Genentech then markets
and sells.
"The words 'engaged in manufacturing' are not to be given a
narrow or restrictive meaning." Assessors of Boston, 323 Mass.
at 748-749. We agree with the board that where such a clear
transformation has occurred, Genentech's drug production
activities qualify as manufacturing within the meaning of § 38
(l).
2. Substantial manufacturing and gross receipts. Under
§ 38 (l) (1), a corporation engaged in manufacturing only
qualifies as a "manufacturing corporation" subject to the
11
single-factor apportionment formula based on sales in § 38 (l)
(2) if it engages "in substantial part" in manufacturing
activities. Genentech claims that even if it is engaged in
manufacturing, it still does not qualify as a manufacturing
corporation because it does not satisfy the necessary test for
engaging in "substantial" manufacturing. The board rejected
Genentech's argument, as do we.
Section 38 (l) (1) sets out five alternative tests for
measuring whether a corporation's manufacturing work is
"substantial," and provides that only one of these tests must be
met.7 The parties agree that the first alternative test is the
7
General Laws c. 63, § 38 (l) (1), provides in relevant
part:
"A manufacturing corporation's activities will be
considered to be substantial if any one of the following
five tests are met:
"1. twenty-five per cent or more of its gross receipts are
derived from the sale of manufactured goods that it
manufactures;
"2. twenty-five per cent or more of its payroll is paid to
employees working in its manufacturing operations and
fifteen per cent or more of its gross receipts are derived
from the sale of manufactured goods that it manufactures;
"3. twenty-five per cent or more of its tangible property
is used in its manufacturing operations and fifteen per
cent or more of its gross receipts are derived from the
sale of manufactured goods that it manufactures;
"4. thirty-five per cent or more of its tangible property
is used in its manufacturing operations; or
12
most apt to Genentech; the first alternative test requires proof
that twenty-five per cent or more of the corporation's "gross
receipts are derived from the sale of manufactured goods that it
manufactures." Id.
The term "gross receipts" in this first alternative is not
defined in § 38 (l). Generally, "where [a] statutory term is
not defined, 'it must be understood in accordance with its
generally accepted plain meaning.'" Ten Local Citizens Group v.
New England Wind, LLC, 457 Mass. 222, 229 (2010), quoting Allen
v. Boston Redevelopment Auth., 450 Mass. 242, 256 (2007).
Genentech argues that the commonly understood meaning of "gross
receipts" is clear (and expansive): the term means the total
amount of receipts received, without deduction for expenses or
other items. Genentech also urges us to read § 38 (l) in
harmony with § 38 (f), which sets out the governing definition
of "sales factor" used in all the § 38 allocation formulas,
whether three-factor or single-factor. As in effect during the
tax years at issue, § 38 (f), inserted by St. 1966, c. 698,
§ 58, provided in relevant part:
"The sales factor is a fraction, the numerator of which is
the total sales of the corporation in this commonwealth
during the taxable year, and the denominator of which is
the total sales of the corporation everywhere during the
taxable year. As used in this subsection, 'sales' means
"5. the corporation's manufacturing activities are deemed
substantial under relevant regulations promulgated by the
commissioner."
13
all gross receipts of the corporation except interest,
dividends, and gross receipts from the maturity,
redemption, sale, exchange or other disposition of
securities" (emphasis added).
Pointing to generally applicable rules of statutory
construction, Genentech argues that because "gross receipts" is
defined in § 38 (f) with a specific exception for receipts from
the redemption or other disposition of securities, whereas no
such exception is included in § 38 (l), "gross receipts" in § 38
(l) must be interpreted to include receipts of all transactions
involving securities, including redemption and return at
maturity. See, e.g., Simmons v. Clerk-Magistrate of the Boston
Div. of the Hous. Court Dep't, 448 Mass. 57, 65 (2006) ("[W]here
the Legislature has employed specific language in one portion of
a statute, but not in another, the language will not be implied
where it is absent").
The board did not adopt the analysis Genentech advances
here. The board noted the volume of transactions whereby
Genentech redeemed and reinvested cash on an almost daily basis,
and pointed out that if Genentech's "gross receipts" were
defined to include the receipts from the redemption or return at
maturity of funds invested in short-term securities, the
percentage of the company's "receipts" related to sales
involving its drugs and other income-generating transactions was
dramatically different, and dramatically lower, than if receipts
14
from what in substance is a return of capital were omitted.8
Using the 2004 tax year as an example, the board pointed out
that if Genentech's interpretation were accepted,
"[Genentech] would have generated $39,226,839,298 in gross
receipts, of which only $4,578,096,817 came from ordinary
business income, such as revenue from the sale of drugs,
royalties from the license of intellectual property,
contract revenue, and investment income in the form of
interest, dividends, and capital gains. The remainder of
those 'gross receipts' would have been derived from
redeeming money market funds or commercial paper for their
cash equivalent, receipts that were not included for
accounting purposes in the measures of revenue reported to
shareholders or included in the computation of taxable
income. Using these figures as a proxy would mean that
approximately 88% of Genentech's overall business
activities in 2004 consisted of a handful of employees in
the treasury department managing Genentech's day-to-day
cash flow."
We agree with the board that such a result is "distortive" of
Genentech's operations, transforming, for Massachusetts
corporate income tax purposes, this self-described biotechnology
8
To include the return of capital initially invested and
redeemed would yield the following percentages of sales from
manufacturing as compared to excluding the return of capital for
the years at issue:
Year Percent of Sales Percent of Sales
from Manufacturing, from Manufacturing,
Return of Capital Return of Capital
Excluded Included
1998 63.5% 3.9%
1999 74.8% 4.4%
2000 67.7% 8.3%
2001 71.5% 5.6%
2002 82.2% 7.1%
2003 72.7% 10.2%
2004 79.6% 9.3%
15
company with substantial revenue derived from sales of its
specialty drugs into essentially an investment business.
Under § 38 (l) (1), gross receipts are considered for
purposes of determining whether a company's manufacturing
activities are a substantial enough portion of its business to
qualify it as a "manufacturing corporation" under the corporate
excise tax statute. Interpreting the absence of a specific
exception in § 38 (l) (1) for receipts from redemption or return
at maturity of securities to mean that the return of all
Genentech's capital invested in short-term securities is to be
included as part of its gross business receipts runs counter to
the reality of Genentech's business and essentially makes no
sense. We do not consider the meaning of "gross receipts," as
used in § 38 (f), to be plain and unambiguous,9 but even if it
were, this court will not interpret a statute according to the
plain meaning of its words where to do so would lead to absurd
9
As noted in Microsoft Corp. v. Franchise Tax Bd., 39 Cal.
4th 750, 763 nn.11, 12 (2006), the California Supreme Court,
looking to various other jurisdictions, acknowledged the lack of
consensus "over whether in a redemption of securities the full
or net price constitutes gross receipts." Id. at 764. It is
true that in the Microsoft case, the California court concluded
that "gross receipts" as used in the tax statute before it, the
Uniform Division of Income for Tax Purposes Act (UDITPA),
interpreted the term to include the entire security redemption
price. Id. at 758-759. However, that court ultimately relied
on a separate provision in UDITPA that provided an alternative
method of measuring a business's income to reject the tax result
that would flow from applying this definition of "gross
receipts" to the company. See id. at 770-771.
 16
or unreasonable results. See, e.g., Bridgewater State Univ.
Found. v. Assessors of Bridgewater, 463 Mass. 154, 158 (2012),
and cases cited.10 The board concluded that the interpretation
advanced by Genentech would have absurd consequences. We agree,
and further accept and agree with the board's interpretation of
the term "gross receipts" in § 38 (l) (1) to be limited to
receipts relating to business income received by Genentech,
including, insofar as investment income is concerned, interest,
dividends, and capital gains. Under this interpretation, as
reflected in note 8, supra, it is clear that during all the tax
years at issue, more than twenty-five per cent of Genentech's
gross receipts were "derived from the sale of manufactured goods
that it manufactures." G. L. c. 63, § 38 (l) (1). Accordingly,
Genentech qualified in each of these tax years as a
"manufacturing corporation" as defined in § 38 (l) (1), and
under § 38 (l) (2), was required to apportion its income under
10
Almost thirty years elapsed between the time the
definition of "sales factor" in § 38 (f) was enacted, see St.
1966, c. 698, § 58, and the establishment of the single-factor
apportionment test for manufacturing corporations in § 38 (l),
see St. 1995, c. 280, § 2. In our review of the legislative
history of § 38 (l)'s enactment, we found no indication that the
Legislature did, in fact, intend the definition of "gross
receipts" to include receipts from the redemption or return of
capital invested in securities, and neither party has suggested
otherwise. The absence of any such indication supports our view
that in the circumstances of this case, it is not appropriate to
follow the rule of statutory construction to which Genentech
points, namely, that the use of specific language in one section
of a statute and its absence in a second section signifies an
intentional omission in the second.
17
the single-factor formula using solely the statute's sales
factor.11
3. The commerce clause.12 Genentech challenges the
constitutionality of § 38 (l), arguing that as applied to it,
the statute violates the dormant commerce clause of the United
States Constitution. See Art. I, § 8, cl. 3, of the United
States Constitution. The claim is that application of the
statute's single-factor apportionment formula to the company, in
combination with the unavailability of what it refers to as the
11
We have focused here on the first alternative test set
out in § 38 (l) (1). The fifth alternative test, which looks at
whether the corporation's manufacturing activities "are deemed
substantial under relevant regulations promulgated by the
commissioner," also is satisfied. The pertinent provisions in
regulations that the commissioner has adopted to guide
apportionment of income and classification of corporations as
manufacturing corporations, see 830 Code Mass. Regs.
§§ 63.38.1(10)(b)(3) (2015) and 58.2.1(6)(e) (1999) --
provisions that state in the regulatory text they are to be read
together -- interpret "gross receipts" as appearing in § 38 (l)
(1) to mean only the interest and dividends earned by a
corporation are to be taken into account as a receipt. Given
that "gross receipts" is not defined in § 38, we look to the
commissioner's regulations and give "substantial deference" to
the expertise and statutory interpretation of the agency
primarily responsible for administration of the statute.
Goldberg v. Board of Health of Granby, 444 Mass. 627, 633
(2005). See Zoning Bd. of Appeals of Amesbury v. Housing
Appeals Comm., 457 Mass. 748, 759-760 (2010), and cases cited.
12
We do not address Genentech's challenge under the equal
protection clause of the United States Constitution, because the
record indicates that the company did not raise any such claim
before the board. See G. L. c. 58A, § 13 ("The court shall not
consider any issue of law which does not appear to have been
raised in the proceedings before the board").
18
Commonwealth's "manufacturing credits,"13 creates a
discriminatory and unfair tax burden that contravenes the
commerce clause test set out in Complete Auto Transit, Inc. v.
Brady, 430 U.S. 274, 279 (1977). Genentech's challenge fails.
a. Background. As stated previously, § 38 establishes
allocation formulas for determining the amount of a business
corporation's net income that is subject to taxation in the
Commonwealth. If a corporation's income is subject to income
tax only in Massachusetts, one hundred per cent of its net
income is taxable here, see § 38 (b), but if the income is
taxable in one or more States in addition to the Massachusetts,
the portion that is subject to tax here will be determined
according to an allocation formula set out in one of the other
subsections of § 38. Before § 38 (l) was added to G. L. c. 63
in 1995, the amount of income tax paid by a manufacturing
corporation with taxable business income in several States was
determined by use of the three-factor apportionment formula in §
13
Genentech defines as "manufacturing credits" the
following three tax measures: the investment tax credit (ITC)
provided for in G. L. c. 63, § 31A; the research and development
credit (R&D credit) in G. L. c. 63, § 38M, and the exemption
from local property taxes on machinery in G. L. c. 59, § 5,
Sixteenth (3). Genentech focuses solely on the ITC and R&D
credit in this appeal, and we do not further discuss the local
property tax exemption for machinery. See Mass. R. A. P. 16 (a)
(4), as amended, 367 Mass. 921 (1978).
19
38 (c).14 See G. L. c. 63, § 38 (c), as amended through St.
1996, c. 264, § 2. The 1995 amendment to § 38 removed
manufacturing corporations from the class of corporations
subject to the § 38 (c) three-factor apportionment formula and
established the single-factor formula based only on sales. See
St. 1995, c. 280, § 2. The single-factor formula was
implemented over four years, beginning in 1996; by the beginning
of 2000, all manufacturing corporations with taxable income in
both Massachusetts and another State were required to apportion
their income using solely the sales factor. See id.
The "manufacturing credits" to which Genentech refers were
enacted long before § 38 (l) was added to the corporate excise
tax statute. Thus, the investment tax credit (ITC), G. L.
14
During the tax years at issue here (and at present), the
three-factor formula established by § 38 (c) operates as
follows: the taxable net income of the corporation was
apportioned "by multiplying [the corporation's taxable net
income] by a fraction, the numerator of which is the property
factor plus the payroll factor plus twice times the sales
factor, and the denominator of which is four." G. L. c. 63,
§ 38 (c), as amended through St. 1996, c. 264, § 2. The
"property factor," the "payroll factor," and the "sales factor"
referred to in § 38 (c) are separately defined in G. L. c. 63,
§ 38 (d), (e), and (f), respectively. As set out in the cited
definitional provisions, each of these factors represents a
fraction, in which the numerator is the corporation's total
payroll, or property, or sales, in the Commonwealth; and the
denominator is the corporation's total payroll, or property, or
sales, "everywhere during the taxable year."
20
c. 63, § 31A, was enacted in 1970, see St. 1970, c. 634, § 2;15
and the research and development credit (R&D credit) described
in G. L. 63, § 38M, was enacted in 1991, see St. 1991, c. 138,
§ 130.16
b. Section 38 (l). The United States Supreme Court "has
long 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." Westinghouse
Elec. Corp. v. Tully, 466 U.S. 388, 398 (1984). The Court also
has "repeatedly held that a single-factor formula is
presumptively valid." Moorman Mfg. Co. v. Bair, 437 U.S. 267,
273 (1978). Genentech claims, however, that the single-factor
apportionment formula in § 38 (l), as applied to it, rebuts this
15
As defined in G. L. c. 63, § 31A (a), the ITC entitles a
manufacturing corporation (among other listed types of
corporations) to a credit against the excise tax due under G. L.
c. 63 of one per cent of the cost of "qualifying" tangible
property -- defined to include tangible personal property and
other property including buildings -- "acquired, constructed,
reconstructed, or erected during the taxable year" that was
"situated in the Commonwealth on the last day of the taxable
year" and depreciable under the Internal Revenue Code with a
useful life of at least four years. The ITC may be used in the
year the expense is incurred, but unused portions may be carried
forward to subsequent tax years. G. L. c. 63, § 31A (g).
16
General Laws c. 63, § 38M (a), provides a credit against
a corporation's corporate excise tax due under G. L. c. 63 for
certain qualifying research expenditures paid during the taxable
year, limited to expenditures for research conducted in
Massachusetts. Like the ITC, the R&D credit may be used fully
during the year the expenditures were incurred but unused
portions may be carried forward. See G. L. c. 63, § 38M (f).
21
presumption of validity because it violates the commerce clause
test established in the Complete Auto Transit case, 430 U.S. at
279, insofar as the formula is (1) discriminatory in relation to
interstate commerce; (2) not fairly apportioned in relation to
the extent of Genentech's activities in Massachusetts; and (3)
not "fairly related to the services provided by the State." Id.
Genentech's complaint, however, centers virtually entirely on
the first Complete Auto Transit test. In particular, Genentech
complains that by requiring the company to use § 38 (l)'s
single-factor apportionment formula based only on sales while
simultaneously denying it the benefit of the ITC and R&D credit,
§ 38 (l) discriminates against the company as a foreign
corporation whose manufacturing activities take place in a State
other than Massachusetts (i.e., California), and therefore
unconstitutionally burdens interstate commerce.
The dormant commerce clause "denies the States the power
unjustifiably to discriminate against or burden the interstate
flow of articles of commerce." Oregon Waste Sys., Inc. v.
Department of Envtl. Quality of Or., 511 U.S. 93, 98 (1994).17
17
See Fulton Corp. v. Faulkner, 516 U.S. 325, 331 (1996),
quoting Chemical Waste Mgt., Inc. v. Hunt, 504 U.S. 334, 342
(1992) ("With respect to state taxation, one element of the
protocol summarized in Complete Auto Transit, Inc. v. Brady, 430
U.S. 274 [1977], treats a law as discriminatory if it "tax[es] a
transaction or incident more heavily when it crosses state lines
than when it occurs entirely within the State"). See also
Boston Stock Exch. v. State Tax Comm'n, 429 U.S. 318, 332 n.12
22
We disagree with Genentech's claim, based on its reading of the
legislative history of § 38 (l), that the statutory change in
the excise tax apportionment formula for manufacturers in 1995
was an intentionally discriminatory one, fueled by a purpose to
benefit local manufacturers directly at the expense of
manufacturers that maintain their manufacturing facilities and
operations in other States. Rather, we read the legislative
history of § 38 (l) as indicating that the purpose of the change
in the apportionment formula was designed to encourage
manufacturers to increase the level of their investment in
manufacturing operations in the Commonwealth by removing a tax
"disincentive" created by the three-factor formula.18,19 The
(1977) (noting that State "may not discriminate between
transactions on the basis of some interstate element"). State
laws discriminating against interstate commerce on their face
are "virtually per se invalid." Oregon Waste Sys., Inc. v.
Department of Envtl. Quality of Or., 511 U.S. 93, 98 (1994), and
cases cited.
18
See letter to Senate and House of Representatives from
then Governor William F. Weld and then Lieutenant Governor Argeo
Paul Cellucci, dated September 5, 1995, enclosing legislative
proposal entitled "An Act to promote job growth in the
Commonwealth"; memorandum to then Governor William F. Weld and
then Lieutenant Governor, Argeo Paul Cellucci, from Gloria
Cordes Larson and David B. Keto, "Q&A's on House No. 5617, 'An
Act Relative to Job Creation and Economic Expansion in the
Commonwealth,'" dated November 21, 1995 (Larson Memorandum);
press release, "Weld, Cellucci Sign Single Sales, Limited
Liability Bills," dated November 28, 1995.
19
The "disincentive" that was perceived was that because a
three-factor apportionment formula takes a corporation's
property and payroll in Massachusetts into account, as well as
23
Supreme Court has recognized this type of business investment
encouragement as a constitutionally appropriate goal. See
Trinova Corp. v. Michigan Dep't of Treasury, 498 U.S. 358, 385-
386 (1991), quoting Boston Stock Exch. v. State Tax Comm'n, 429
U.S. 318, 336 (1977) ("It is a laudatory goal in the design of a
tax system to promote investment that will provide jobs and
prosperity to the citizens of the taxing State. States are free
to structure their tax systems to encourage the growth and
development of interstate commerce and industry" [quotation
omitted]).
It is true, as Genentech points out, that when the 1995
change in the apportionment formula for manufacturing
corporations from one using an income allocation formula that
includes Massachusetts property and payroll to one focusing
solely on Massachusetts sales occurred, it may well have caused
the amount of income apportioned to Massachusetts to decrease
for manufacturing corporations that conducted their
manufacturing operations in the Commonwealth, and have had the
opposite effect on such corporations, like Genentech, with their
its Massachusetts sales, any increase in the company's
manufacturing operations in the Commonwealth -- presumably
resulting in an increase in the company's Massachusetts-based
property and personnel -- would cause an increase in its excise
tax apportionment factor and thereby an increase in the portion
of its income subject to Massachusetts tax. See Larson
Memorandum at 2.
24
manufacturing facilities elsewhere.20 But the dormant commerce
clause does not forbid a State from changing the allocation
formula it uses to determine what share of the income generated
by a multistate corporation operating in the taxing State is
fairly subject to tax. As previously stated (see note 17,
supra), what the commerce clause forbids as discriminatory is a
State tax measure that "tax[es] a transaction or incident more
heavily when it crosses state lines than when it occurs entirely
20
The reason a manufacturing corporation with sales in
Massachusetts and other States but with its manufacturing
operations significantly located in Massachusetts would benefit
from the change in allocation formulas is that the corporation's
investment in property and payroll in the Commonwealth become
irrelevant as factors influencing the allocation formula. See
note 19, supra.
The reason a manufacturing corporation such as Genentech,
with sales in the Commonwealth but manufacturing operations
elsewhere would likely experience an increase in the amount of
its income apportioned to Massachusetts when the apportionment
method changed to a single-factor formula is illustrated by the
following example. Assume a manufacturing corporation had sales
in the Commonwealth that amounted to ten per cent of its over-
all sales, but one hundred per cent of its manufacturing and
other property as well as one hundred per cent of its
manufacturing employees were located in another State. Under
the three-factor allocation formula in § 38 (c) that previously
applied, the corporation's allocation factor would be
effectively determined by dividing only twice times its sales
factor by four:
0 property factor + 0 payroll factor (0) + 2(.10 sales factor)
4
See note 14, supra. Under the new allocation formula in § 38
(l), however, at least beginning in 2000 and going forward, this
same manufacturing corporation's allocation factor would be the
.10 sales factor itself, that is, undivided by 4.
25
within the State." Chemical Waste Mgt., Inc. v. Hunt, 504 U.S.
334, 342 (1992), quoting Armco Inc. v. Hardesty, 467 U.S. 638,
642, (1984). See Boston Stock Exch., 429 U.S. at 337 (State may
not "discriminatorily tax the products manufactured or the
business operations performed in any other State"); id. at 332
n.12 (State "may not discriminate between transactions on the
basis of some interstate element"). The single-factor
apportionment formula prescribed by § 38 (l) does not commit any
such sin. It uses the same apportionment formula to tax every
multistate manufacturing corporation's income generated from its
sales in the Commonwealth, treating every corporation, whether
foreign or domestic, exactly the same. More to the point, the
formula treats the income from every sales transaction involving
manufactured goods exactly the same, no matter where the
corporation's manufacturing operations may be located. Compare,
e.g., New Energy Co. of Ind. v. Limbach, 486 U.S. 269, 274
(1988) (Ohio fuel tax credit for Ohio-produced fuel
unconstitutionally discriminates against products of out-of-
State manufacturer in violation of commerce clause); Bacchus
Imports, Ltd. v. Dias, 468 U.S. 263, 271-272 (1984) (Hawaii tax
exemption solely for liquor produced in Hawaii
unconstitutionally discriminatory). The single-factor
apportionment formula based on sales in § 38 (l), on its face or
26
as applied to Genentech, does not discriminate against
interstate commerce.
Nor does the unavailability of the ITC or the R&D credit to
a manufacturing corporation like Genentech, that has chosen to
conduct its manufacturing operations and perform research and
development activities in a State other than Massachusetts,
change this result. It is true that these credits, if available
to a manufacturing corporation, are available to reduce the
corporation's excise tax burden. But the credits were in
existence long before § 38 was amended in 1995 to add § 38 (l)
for manufacturing corporations; are available to a variety of
corporations in addition to manufacturing corporations; and are
clearly designed to encourage companies to locate operations in
Massachusetts and thereby invest in the economy of the State.
The commissioner points out that many States have adopted
similar investment tax and R&D tax credits, including
California; the record indicates that Genentech has qualified
for and used California's equivalent credits against its
California tax burden for many years.21 The availability of
these credits, which are tied to investments of resources in the
Commonwealth, are available to any manufacturing corporation,
foreign or domestic, and operate independently of the
21
The record also reflects that in one or more of the tax
years at issue here, Genentech itself qualified for and used the
Massachusetts R&D credit.
27
corporation's interstate sales or other interstate commercial
activities, does not violate the commerce clause. See New
Energy Co. of Ind., 486 U.S. at 278 ("The Commerce Clause does
not prohibit all state action designed to give its residents an
advantage in the marketplace, but only action of that
description in connection with the State's regulation of
interstate commerce. Direct subsidization of domestic industry
does not ordinarily run afoul of that prohibition;
discriminatory taxation of out-of-state manufacturers does"
[emphasis in original]). See also Fireside Nissan, Inc. v
Fanning, 30 F.3d 206, 216 (1st Cir. 1994).
Decision of the Appellate
Tax Board affirmed.