MOBAY CHEMICAL CORPORATION, PLAINTIFF-RESPONDENT, v. DIRECTOR, DIVISION OF TAXATION, DEFENDANT-APPELLANT.
Supreme Court of New Jersey
Argued November 9, 1983—Decided June 1, 1984.
96 N.J. 407
I therefore dissent.
Justice O‘HERN joins in the dissenting opinion.
Fоr reversal—Justices CLIFFORD, SCHREIBER, POLLOCK and GARIBALDI—4.
For affirmance—Justices HANDLER and O‘HERN—2.
Harry Haushalter, Deputy Attorney General, argued the cause for appellant (Irwin I. Kimmelman, Attorney General of New Jersey, attorney; James J. Ciancia, Assistant Attorney General, of counsel).
Kevin J. Coakley submitted a brief on behalf of amicus curiae Hilton Hotels Corporation (Connell, Folеy & Geiser, attorneys; Patrick J. McAuley, on the brief).
Walter R. Davis, Jr., submitted a brief on behalf of amicus curiae Prudential Insurance Company of America (Walter R. Davis, Jr., attorney; Nancy W. Proudfit, on the brief).
The opinion of the Court was delivered by
SCHREIBER, J.
This case, like its companion, Fedders Financial Corp. v. Director, Div. of Taxation, 96 N.J. 376 (1984),
The Director of the New Jersey Division of Taxation, Department of the Treasury (the Director), determined that plaintiff, Mobay Chemical Corporation, in computing its tax liability under the Act for the year 1974, should have included in the calculation of plaintiff‘s “net worth” under
The taxpayer‘s appeal to the then-existing Division of Tax Appeals was transferred to the Tax Court in accordance with
The parties stipulated the facts. Plaintiff, a New Jersey corporation, was the product of a merger in 1971 of six affiliated companies of Farbenfabriken Bayer Aktiengesellschaft (Bayer A.G.), a corporation organized under the laws of the Federal Republic of Germany. Plaintiff has been primarily involved in manufacturing and marketing chemical products such as polyurethanes, thermoplastics, and synthetic fibers. As of December 31, 1974, the relevant date for this tax assessment under the Act, plaintiff‘s stock was owned by Rhinechem Corporation, whose stock in turn was owned by Bayer International Finance N.V., whose stock in turn was owned by Bayer A.G. Another wholly owned subsidiary of Bаyer A.G. was Baychem Funding Corporation (Baychem Funding), whose sole function was to serve as a vehicle for debt financing for the plaintiff. Another Bayer A.G. subsidiary that played a part in the debt financing was Bayer Nederland B.V. The corporate schematic was as follows:
On December 31, 1974, the plaintiff was indebted in the principal amount of $56,000,000 to Baychem Funding. At issue is whether this indebtedness owed to аn affiliated corporation with a common parent, Bayer A.G., which the Director claims is owed indirectly to that parent, is includible in calculating the plaintiff‘s net worth. Also at issue is whether 90% of the interest paid by the plaintiff on that indebtedness is includible in the plaintiff‘s net income.
To determine if the $56,000,000 debt is owed directly or indirectly to Bayer A.G., it is necessary to examine the history and reason for thе debt. In 1971, when the predecessor corporations were merged into the plaintiff, the plaintiff assumed the debts of one of its predecessors owed to The Prudential Insurance Company of America (Prudential) and the Equitable Life Assurance Society of the United States (Equitable Life). Subsequently, the plaintiff entered into new note agreements with Prudential and Equitable Life increasing the indebtеdness by additional borrowings so that the total loan was $55,000,000. These debts are not at issue. What is important is that these note agreements, like the prior agreements, prohibited plaintiff from entering into any long-term debt obligations, except with Bayer A.G. or a subsidiary of Bayer A.G. In order, among other things, to obtain additional funds without violating the conditions in the note agreements, it was decided that an affiliated company would borrow funds from the public and in turn make loans to plaintiff‘s predecessor. Accordingly, in 1969, Bayer International Finance issued and sold on the European market $75,000,000 of its 6% bonds due November 1, 1981. Bayer International Finance in turn loaned $56,000,000 of these proceeds to three of plaintiff‘s predecessors. Upon the merger of these debtor companies into plаintiff, the debt was consolidated and assumed by plaintiff. The promissory notes of the plaintiff evidencing this indebtedness were purchased in 1973 from Bayer International Finance by Bayer Nederland B.V., another subsidiary of Bayer A.G.
In 1972 Baychem Funding was formed for the sole purpose and exclusive business of serving as a vehicle to enable plaintiff to borrow in the United States in conformity with the covenants сontained in plaintiff‘s note agreements with Prudential and Equitable Life. In 1973 Baychem Funding borrowed from five banks and used the loan proceeds to purchase from Bayer Nederland B.V. the plaintiff‘s promissory notes in the aggregate face amount of $56,000,000. Baychem Funding simultaneously entered into a loan agreement with plaintiff under
The principles we have enunciated today in Fedders Financial Corp. v. Director, Div. of Taxation, supra, are equally applicable here. First, it is clear that plaintiff was not directly or indirectly obligated to its immediate parent, Rhinechem Corporation.2 Second, plaintiff was not directly or indirectly obligated to its indirect parent, Bayer A.G., for the $56,000,000. Unlike the indication in the opinion of the Tax Court, 3 N.J. Tax at 607, an indebtedness owed by the taxpayer to an affiliated corporation is presumed to be indirectly owed to the common рarent, unless the affiliated corporation is shown to have been the conduit of funds from a non-affiliated source.
The plaintiff is entitled to exclude from its net worth the debts aggregating $56,000,000 owed to Baychem Funding and to deduct the entire amount of the interest paid on that indebtedness for the year 1974. The judgment is affirmed.
HANDLER, J., dissenting.
This appeal by the Director, Division of Taxation (Director), questions the determination by the Tax Court that a debt owed by Mobay Chemical Corporation (Mobay), to an affiliated corporation did not constitute an indebtedness owed directly or indirectly to a ten per cent or more stockholder under the Corporation Business Tax Act,
The facts in this case were stipulated. Mobay, the taxpayеr corporation, and Baychem Funding Corporation (Baychem Funding), were effectively owned and controlled by Bayer A.G., the major parent of a group of corporations. The Bayer group was involved in the production, manufacture and marketing of dyestuffs, textile auxiliaries, organic and inorganic chemicals, plastics, synthetic rubber, pigments, pharmaceuticals, fibers, pesticides, photographic equipment and other chemical products.
It behooves us to spend some time in mastering the kaleidoscopic corporate constellation of which the taxpayer is an integral part. We start through the intricate and convoluted corporate maze with Mobay‘s incorporation in the State of New Jersey in 1971, under the name оf Baychem Corporation. Its name was changed in 1974 to Mobay Chemical Corporation. Mobay (then Baychem), was itself the product of a merger of six subsidiaries of Farbenfabriken Bayer Aktiengesellschaft (Bayer A.G.), a corporation organized under the laws of the Federal Republic of Germany. Initially, Mobay was owned by three corporations: Bayer A.G., Bayer Foreign Investments Limited (Bayforin), and Bayer International Finance N.V., a Netherlands Antilles corporation. Both Bayforin and Bayer International Finance were wholly owned subsidiaries of Bayer A.G. In 1973, Mobay became a wholly owned subsidiary of Bayer International Finance. Later that year, Bayer International Finance founded Rhinechem Corporation (Rhinechem), which in 1974 acquired from Bayer International Finance the
The particular debt that occasioned this appeal requires us to examine some of the financial history of this corporate family. In 1968 and 1969, two of Mobay‘s predecessor corporations engaged in long-term financing with Prudential Insurance Company of America and Equitable Life Assurance Society of the United States. Mobаy assumed and refinanced these obligations, amounting to $55 million, as evidenced by promissory notes that included unconditional guaranties of payment of principal and interest by Bayer A.G. Bayer International Finance, in late 1969, issued bonds totalling $75 million, which were sold on the European Market, and, by 1972, had loaned $56 million to the predecessor corporations of Mobay, which, upon their merger into Mobay, became a liability owed by Mobay to Bayer International Finance.1
Baychem Funding Corporation then entered into a $56 million loan agreement with five banking corporations, using the proceeds to purchase from Bayer Nederland B.V. the promissory notes of Mobay. At the same time, Baychem Funding loaned Mobay $56 million, evidenced by separate promissоry notes that also contained the guarantee by Bayer A.G. with regard to payment of principal and interest. Thus, as of December 31, 1974, Mobay was indebted to Baychem Funding in the amount of $56 million, which indebtedness was fully guaranteed as to
Procedurally, Mobay filed a corporation business tax return for its 1974 calendar year on September 11, 1975. The return was subsequently amended to request a refund of taxes on the ground that the indebtedness in question was incorrectly reflected on the original tax return as being owed to a ten per cent or more stockholder of Mobay and therefore disallowed as a deduction for its statutory net worth. The Director, in a letter determination, denied Mobay‘s refund claim.
The Director determined that the $56 million indebtedness owed by Mobay to Baychem Funding constituted an indebtedness owed to Bayer A.G., which directly and indirectly owned and controlled both debtor and creditor corporations, and consequently was properly disallowed in сomputing statutory net worth. The Tax Court, however, reversed the Director‘s determination, ruling that Baychem Funding was an undercapitalized corporate shell that acted as a mere conduit and, therefore, was not the actual creditor of the $56 million loaned to Mobay. 3 N.J. Tax 597 (Tax Ct.1981). In an unpublished per curiam opinion the Appellate Division affirmed the Tax Court‘s ruling. The Director filed a notiсe of appeal from this judgment.
Unlike the majority, I would reverse the lower courts’ judgment, based upon the legal analysis and reasoning that commended my dissent in Fedders Financial Corp. v. Director, Div. of Taxation, supra, 96 N.J. at 394. In my opinion, the Director properly determined that the $56 million liability owed by plaintiff to Baychem Funding constituted an includible taxable indebtedness in accordance with the statutory language of
The majority accepts the reasoning set forth by the Tax Court in support of its reversal of the Director‘s determination. The Tax Court concluded that the $56 million loan arrangement between Mobay and Baychem Funding was not a disguised contribution to capital. It also found that Baychem Funding was essentially an undercapitalized shell сorporation acting as a mere conduit in securing outside credit for Mobay. In accepting these conclusions, the Court misconceives the conceptual underpinnings of the special indebtedness provisions of the Act and disregards the bright line test of nexus and control established as the exclusive determinant for the special tax classification of corporаte-stockholder debt. Kingsley v. Hawthorne Fabrics, Inc., 41 N.J. 521, 525-26 (1964); Werner Machine Co., Inc. v. Zink, 6 N.J. Super. 188 (App. Div. 1950).
To reiterate, the facts in this case convincingly establish that Bayer A.G. controlled and directed the operations of the entire Bayer group of corporations. Mobay was formed to manufacture and market Bayer A.G.‘s product lines in the United States. Mobay itself was the result of a merger of various corporations owned and controlled by Bayеr A.G. Baychem Funding was formed solely to facilitate debt financing for Mobay.
It may be accepted that the $56 million indebtedness was bona fide and for a legitimate business purpose. That, however, is not relevant to the determinative consideration of whether such indebtedness is directly or indirectly owed to a ten per cent or more stockholder within the terms of the Act. As I stressed in Fedders Financial Corp., supra, 96 N.J. at 406, the tax authorities are not required to follow the convolutions of the taxpayer‘s business strategy in arriving at the
The Tax Court‘s consideration of whether Baychem Funding was a viable corporation, accepted by the majority, is also misplaced. The record clearly reflects that Baychem Funding was a real and functioning corporate entity specifically created to fаcilitate the debt financing of Mobay. The capitalization of Baychem Funding was not germane to its corporate purpose. Baychem Funding used the proceeds from the $56 million loan arrangement to acquire the $56 million liability Mobay owed to Bayer Nederland B.V. The fact that Baychem Funding may have acted as a “conduit” in securing financing for Mobay does not impugn the transaсtion or negate Baychem Funding‘s corporate status or identity. The identical contention was explicitly rejected in General Public Loan Corp. v. Director, Div. of Taxation, 13 N.J. 393 (1953). There a “conduit arrangement” utilized by the parent to provide its subsidiary with outside credit was not considered a proper justification for avoiding the application of the special indebtedness provisions of the Act. 13 N.J. at 400-01. The fact that Baychem Funding utilized outside credit sources in order to assume the $56 million indebtedness owed by Mobay to Bayer Nederland B.V. does not negate the existence of the indebtedness between Baychem Funding and Mobay. That indebtedness was so structured by Bayer A.G. to facilitate its operations in the United States through subsidiary instrumentalities. Mobay should not be permitted to disavow its own corporate structure or intercorpоrate transaction in order to avoid the tax consequences that follow from its conscious decision.
We recognized this principle in Household Finance Corp. v. Director, Div. of Taxation, 36 N.J. 353, 363 (1962), noting that the State is not required to “explore the ramifications of corporate structures to determine the justice of recognizing corporate entities in each factual complex.”
[W]hile a taxpayer is free to organize his affairs as he choоses, nevertheless, once having done so, he must accept the tax consequences of his choice,
whether contemplated or not.... (quoting Commissioner v. National Alfalfa Dehydrating & Milling Company, 417 U.S. 134, 149 [94 S. Ct. 2129, 2137], 40 L. Ed. 2d 717 (1974).)
See also General Trading Co. v. Director, Div. of Taxation, supra, 83 N.J. at 136-37; Somerset Apts. v. Director, Div. of Taxation, 134 N.J. Super. 550, 556-57 (App. Div. 1975).
The Tax Court and the majority also misconceive the significance of the guarantee by the major parent, Bayer A.G., of the $56 million loan arrangement between Mobay and Baychem Funding. The characterization of this liability as an includible indebtedness in measuring the net worth tax base under the Act cannot be influenced by the Bayer A.G. guarantee. Rather, the guarantee emphasizes the significance of the control exercised by the parent over the entire group of Bayer companies and underscores the affiliation between the debtor and creditor corporations in this case.
I am satisfied, therefore, that the $56 million liability owed by Mоbay to Baychem Funding as of December 31, 1974 constituted a debt indirectly owed to a ten per cent or more stockholder within the meaning of the indebtedness provisions of the Act, since Bayer A.G. clearly owned and controlled both affiliated corporations. In my view, the Director properly required the inclusion of the $56 million in computing Mobay‘s net worth tax base and in disallowing ninety pеr cent of the interest expense related to this indebtedness in calculating Mobay‘s net income tax base under the franchise tax act.
Accordingly, I dissent from the majority‘s opinion in this case.
O‘HERN, J., joins in the dissenting opinion.
For affirmance—Justices CLIFFORD, SCHREIBER, POLLOCK and GARIBALDI—4.
For reversal—Justices HANDLER and O‘HERN—2.