Indiana Law Review


XIII. Taxation

Marc A. Hetzner*
Paul F. Lindemann**

A. Introduction

This Survey Article is concerned with recent developments in the

area of Indiana state taxation. Included in this Article are the most

important cases concerning corporate gross income tax, inheritance tax,

sales tax, and property tax. Of particular importance is a decision by
the Supreme Court of Indiana concerning the exemption from sales tax

for the purchase of equipment to be directly used in direct production.

Also included in this Article are recent statutory developments concerning

individual adjusted gross income tax, corporate partnerships, small busi-

ness corporations, and the county option income tax. The discussion

also includes an important administrative announcement pertaining to

Indiana's position as it applies to the principles of unitary taxation to

corporations doing business in Indiana. This issue arose after a United

States Supreme Court decision which enhanced the authority of the states

to tax the income of foreign affiliates of corporations doing business

in their state.

B. Gross Income Taxation

In Indiana Department of State Revenue v. Kroger Co.,^ Kroger
claimed that trading stamps given to customers at the time of purchase

reduced its gross receipts and thereby subjected only the price paid by
the customer less Kroger's cost for the trading stamps to the gross

income tax. The Indiana Gross Income Tax Act^ provides that gross
income, except as otherwise provided, includes the "gross receipts of

the taxpayer received from trades, businesses, or commerce."^ The statute

*Associate with the firm of Krieg DeVault Alexander & Capehart—Indianapolis.
A.B., Indiana University, 1975; M.B.A., 1983; J.D., Indiana University School of Law

—

Indianapolis, 1983.

**Partner with the firm of Krieg DeVault Alexander & Capehart—Indianapolis, B.A.,
Valparaiso University, 1970; J.D., Indiana University School of Law—Indianapolis, 1976.

'453 N.E.2d 1175 (Ind. Ct. App. 1983).

^IND. Code §§ 6-2-1-1 to 36 (1976) (recodified at Ind. Code §§ 6-2.1-1-1 to 6-2.1-
8-10 (1982)). Many of the cases in this Survey Article were decided under the 1976 version
of the Indiana Code. Although much of the tax code was recodified in the 1982 version,

the changes, except where noted, were not substantial, and the current version is cited

parenthetically where the applicable code section has been replaced.

'Ind. Code § 6-2-l-l(m) (1976) (recodified at Ind. Code § 6-2.1-l-2(a)(l) (Supp.

1984)).

389



390 INDIANA LAW REVIEW [Vol. 18:389

also provides a specific exclusion for the amount of "cash discounts

allowed and taken on sales. '"^ Kroger argued that giving Top Value
Trading Stamps to its customers who could redeem the stamps for
merchandise or, pursuant to state law, receive cash based on their cash

redemption value from Kroger or Top Value^ reduced Kroger's "gross
receipts."

The Department of Revenue claimed that the issuance of the trading

stamps was not a cash discount but a "cost of doing business."^ The

Department found the distribution of trading stamps to be more in the

nature of an "advertising ploy," not a cash discount to Kroger cus-

tomers.^ The court stated it had not previously addressed this precise

issue and found most closely analogous to it the case of Indiana De-

partment of State Revenue v. Marsh Supermarkets, Inc.^ Although Marsh
involved a question under sales tax law, the central issue was whether

or not the distribution of coupons to customers, entithng them to

discounts on certain Marsh items, reduced the amount of the sale subject

to sales tax to the price less the discount distributed to the customer.

The court stated that in Marsh it had found in favor of the taxpayer

because the coupons' "effect was to lower the price paid by customers."^

The court noted that it also had held that supplier discounts were exempt

from sales tax because they lowered the price paid by the taxpayer to

its supplier and therefore did not contribute to Marsh's gross income. '°

In Kroger, the court recognized that Marsh was distinguishable in that
it was a sales tax case, the discounts were "received" by Marsh and

not its customers, and the discounts clearly reduced the price paid to

Marsh. '•

In reviewing similar cases of other jurisdictions, the court noted a

crucial distinction with respect to these cases and Indiana law which

requires that the trading stamps of Kroger must be redeemable for cash.'^

This caused the court to conclude that the issuance by Kroger of the

Top Value Trading Stamps was a "cash discount."'^ The court concluded
that even without the existence of the specific statute requiring that the

stamps be redeemable for cash it would have, nevertheless, held that

the stamps represented a cash discount."^

^ND. Code § 6-2-l-l(m) (1976) (recodified at Ind. Code § 6-2.1-l-2(c)(ll) (Supp.
1984)).

'Ind. Code § 24-4-2-3 (1982).
H53 N.E.2d at 1177.
'Id.

M12 N.E.2d 261 (Ind. Ct. App. 1980).
''453 N.E.2d at 1177.

''Id. at 1178.

'Ud. (citing Ind. Code § 24-4-2-2 (1982)).
'M53 N.E.2d at 1178.

''Id. (citing Eisenberg's W^hite House, Inc. v. State Bd. of Equalization, 72 Cal.



1985] SURVEY—TAXATION 391

The court recognized that both parties made compelHng arguments
for their position.'^ Based upon its analysis of the "economic effect of

the trading stamps," the court concluded that they were "cash discounts"

because they were redeemable in cash and because they had a cash

value. '^ Kroger customers purchasing items and receiving trading stamps

were deemed to have received something of value in return for their

purchase which ultimately reduced the net proceeds to Kroger, even

though Kroger received the collateral benefit of the advertising.'^

In Kroger, the Indiana Court of Appeals provided sound reasoning

for its holding that the gross income of a retail grocer does not include

the value of trading stamps. Nevertheless, the court's approach in de-

termining the reduction to the grocer's gross income is not entirely

consistent with the applicable statutes. The court, apparently at the

request of Kroger, permitted Kroger to reduce its gross income by the

value of its payment to Top Value Trading Stamps for Kroger's purchase
of these trading stamps. The court did not indicate whether it considered

the payments by Kroger to Top Value as equivalent to that value which
the customers received by way of the trading stamps upon their purchases
from Kroger. The focus of the opinion is that customers pay Kroger

in cash for their purchases and receive the purchased items plus certain

trading stamps which are considered to reduce the cash received by

Kroger upon the purchase. It would seem, therefore, that the reduction
for gross income tax purposes should be the actual value of the trading

stamps issued to customers throughout the year in question.

The premise that the payment by Kroger to Top Value was equivalent
to the value paid by Kroger to its customers presents at least two

problems. First, the payments by Kroger to Top Value would not nec-
essarily occur in the same tax year and in the same amount as the actual
distribution of stamps to Kroger's customers. In fact, it would seem

that in order for Kroger to have the stamps available for distribution

to customers, the purchase of these stamps would occur at a time prior

to the actual sale of goods and distribution of stamps to the customers.

The second problem with using the price paid by the grocer to the

trading stamp issuer is that there is no assurance that the price paid to

the trading stamp company will necessarily equal or exceed the value
of the trading stamps to receiving customers. It is conceivable that

trading stamp companies require some sort of a premium from the grocer
purchasing trading stamps in order to obtain a profit on the transaction.

If this is so, then the reduction to the grocer's gross income under

Kroger will be greater than the value of the stamps distributed.

App. 2d 8, 164 P.2cl 57 (1945)).

'M53 N.E.2d at 1177.

'"/cf. at 1179.

''Id.



392 INDIANA LAW REVIEW [Vol. 18:389

In any event, it would appear that the reduction against gross income

for the payment of trading stamps to customers should be a value based

upon the number of stamps distributed in the tax year to customers of

the taxpayer. A logical value for reduction of the grocer's gross income
amount would be based upon the redeemable face value of the trading

stamps actually issued. This requirement might be more burdensome

upon the taxpayer, but it is he who desires the reduction of his gross
income tax liability. Furthermore, to permit a reduction based upon the

taxpayer's payment to a trading stamp company ignores that the basis
of this reduction is grounded in the fact that the stamps, when given
to the customers, reduce "both the ultimate price paid by their recipients

and the net proceeds received by [the taxpayer].'"^

In United Artists Theatre Circuit, Inc. v. Indiana Department of
State Revenue, ^'^ United Artists claimed that the portion of its receipts

from film viewers which was paid to the film distributors was not subject

to gross income tax because it had received this portion of the payments

either on behalf of the distributor, or as a special agent merely collecting

for the distributor. The Indiana Court of Appeals held that United
Artists was subject to gross income tax on the entire amount of its

receipts from movie patrons. ^°

United Artists owns various theaters throughout Indiana at which

it shows films to the general public. The rights to show these films

during the years in question were acquired from third party film dis-

tributors under two types of licenses. In the first type of agreement,

which was seldom used. United Artists paid a fixed charge to the

distributor for the right to show a movie. The second and most common
type of agreement provided that United Artists pay the film distributor

a percentage of the gross receipts from admissions. United Artists was

permitted under these agreements to reduce the payments to distributors

for a "house allowance. "^^ The house allowance was usually based on

a fixed dollar amount and was to compensate United Artists for its

operating expenses. ^^ In those cases where no house allowance was

deducted, a lesser percentage was paid to the film distributor for the

right to show the film. The United Artists agreements which were based
on percentage amounts sometimes contained trust clauses which stated

that the percentage of the admissions payable to the distributor was

held by United Artists in trust for the distributor. ^^

At the outset, the court found that United Artists' argument was

''Id.

"459 N.E.2d 754 (Ind. Ct. App. 1984).
2°M at 758-59.

^'Id. at 755-56.

^Ud. at 757.

^'Id.



1985] SURVEY—TAXATION 393

"tantamount to claiming an exemption."^'' Thus, the court held that the

tax statutes would be strictly construed against the taxpayer since it was

claiming an exemption. ^^

The court agreed with United Artists' first argument that receipts

received on behalf of a third person do not subject the persons receiving

such payments to the gross income tax.^^ However, United Artists was

unsuccessful in convincing the appellate court that the trial court had

erred in finding that United Artists was the owner of the entire admissions

upon receipt. The court reviewed the trial court's finding that the film

agreements, while entithng the distributor to a percentage of the ad-

missions, were more in the nature of a rental agreement which were

business expenses of United Artists and unavailable for deduction from

its gross income. The trial court had concluded that the provisions in

the agreements ensuring its collection of the distributor's percentage of

admissions were merely a means of securing payment, and that these

payments were expenses of United Artists in doing business. ^^

The United Artists court referred to the Indiana Supreme Court

case of Gross Income Tax Division v. Warner Brothers, ^^ which concerned

the question of whether or not Warner Brothers was engaged in interstate

commerce and thus exempt from gross income tax. In Warner Brothers,

the Indiana Supreme Court held that Warner Brothers was not engaged

in interstate commerce: "[N]or can we see that the license agreement,
providing for a percentage of the exhibitor's admission price as the

license fee, changes the character of the transaction."^^ The United Artists

court recognized that this was not a binding argument against United

Artists, but it also recognized that this holding was valid as to the logic

that a percentage of the exhibitor's admission fee does not change the

character of the transaction. ^°

Reviewing the facts, the court indicated that the agreement's provision

entitling United Artists to a "house allowance" indicated that the parties

^Vc^. at 756.

"M (citing Indiana Dep't of State Revenue v. Boswell Oil Co., 148 Ind. App. 569,
268 N.E.2d 303 (1971)).

^M59 N.E.2d at 756-57 (citing Indiana Dep't of Revenue v. Waterfiled [sic] Mtg.

Co., 400 N.E.2d 212 (Ind. Ct. App. 1980); Department of Treasury v. Ice Serv., Inc.,

220 Ind. 64, 41 N.E.2d 201 (1942)).

2^59 N.E.2d at 757.

^«233 Ind. 345, 118 N.E.2d 117 (1954).

^''Id. at 348, 118 N.E.2d at 119.

^°459 N.E.2d at 757 n.2. The court in this footnote revealed that United Artists had

contended that the Department of Revenue should not be allowed to rely on Warner

Brothers because this case had been repudiated by later Department of Revenue regulations.

The court conceded this was correct; however, the fact that this holding was now contrary
to Department of Revenue regulations did not supersede the reasoning of Warner Brothers,

at least to the extent that it commented upon a percentage of license agreement and its

change upon the character of the transaction.



394 INDIANA LAW REVIEW [Vol. 18:389

treated the entire admission fees as gross income, since all calculations

were made on the total admissions after deduction for "the house
allowance."^' Moreover, United Artists had not segregated that percentage

of fees which was payable to the distributors into a separate banking

account, but rather paid it from its own accounts. ^^ The court made
no mention of what effect segregation of funds might have had upon

the outcome of this case.

United Artists also claimed that the portion of admissions received

and eventually paid to the movie distributors had been received as a

special agent for the distributor." United Artists argued it was merely

a collection agent for the distributors due to the requirement that special

prenumbered tickets be utilized and because the distributor had a right

to audit records of United Artists and monitor theater premises. ^"^ The

distributor also retained many rights regarding the actual showing of
the films and almost total control of advertising related to the films.

The trial court, however, found nothing in the licensing agreements

indicating that United Artists was an agent for the distributors for any

purpose and that any allegations of agency were uncorrobrated.^^

The court of appeals found United Artists distinguishable from

Indiana Department of Revenue v, Waterfiled [sic] Mortgage Co. ,^^ where

it was held that a mortgage company collecting mortgage payments and
transferring those amounts, which included interest, to the appropriate

bank was merely a conduit and not subject to gross income tax. Fur-

thermore, the court denied United Artists' claim that it was a special

agent, because the real nature of the agreements revealed that they were

rental agreements which based the payment to the film distributor upon

a percentage of the receipts from admission. ^^

The final issue in United Artists was whether or not the trial court's

scope of review was limited to the facts presented to the Department

of Revenue in administrative hearings. The trial court had held that the

scope of its review was limited to facts presented to the Department

and that the facts found by the Department were presumed to be valid. ^^

United Artists argued, and the appellate court agreed, that a taxpayer's

claim for gross income tax refunds was to be held de novo upon trial. ''^

However, since United Artists failed to show any evidence was excluded

by the trial court nor did it offer to prove evidence which had been

''Id. at 758.

''Id.

''Id.

MOO N.E.2d 212 (Ind. Ct. App. 1980).
"459 N.E.2d at 759.

''Id.

'"Id.



1985] SURVEY—TAXATION 395

excluded, the court concluded that the trial court's finding constituted

harmless error/°

C Inheritance Tax
The issue in In re Estate of Pfeiffer v. Henry"^^ was the manner in

which the estate was permitted to allocate inheritance tax deductions.

The decedent's will provided that expenses were to be paid from the

residuary assets of the estate. The estate's expenses consumed assets so

as to leave no residual properties and no abatement"^^ of a portion of

specific devises. ^^ For purposes of inheritance tax, the estate propor-

tionately allocated the estate's expenses^'* among all the assets of the
estate. The Department of Revenue objected, claiming that the expenses

should be directly allocated to those assets which were reduced pursuant

to the provisions of the decedent's will."^'

The court held that the estate's method of apportionment was in-

correct because "[l]ogic dictates that a deduction must be attributed only

to the party which expends the resources which constitute the deduc-

tion.'"^^ In so holding, the court found that a deduction should be treated

under the same standard as an exemption, which is to construe any

ambiguity in the law against the party claiming the exemption.
"^^

In Indiana Department of State Revenue v. Estate of Broyles,'^^ the

estate did not pay the inheritance tax within the required eighteen month
time period from the date of the decedent's death. This resulted in the

imposition of a ten percent interest penalty on the deliquent portion of the

inheritance tax from the date of death until the time of payment. "^"^ The

probate court's final determination of the inheritance tax in the amended
Order Determining Value of Estate and Amount of Tax added ten percent

"^Id. at 759-60.

^452 N.E.2d 448 (Ind. Ct. App. 1983)

''-The abatement of the decedent's residual bequest and specific devise was made

pursuant to Indiana Code section 29-1-17-3. There was no controversy as to whether the

abatement had been made pursuant to statutory requirements.
^H52 N.E.2d at 450.

""Indiana Code section 6-4. 1-3- 13(b) provides the applicable language for the deduction

of estate expenses for inheritance tax purposes: "The following items, and no others,

may be deducted from the value of property interests transferred by a resident decedent

under his will, under the laws of intestate succession, or under a trust . . . ." Ind. Code

§ 6-4.1-3-13(G) (1982).

^H52 N.E.2d at 451.

''Id.

''Id. at 452.

M57 N.E.2d 250 (Ind. Ct. App. 1983).
""Id. at 252. Interest on the tax runs from the date of death until payment is actually

made.



396 INDIANA LAW REVIEW [Vol. 18:389

interest charge^° to the delinquent tax due.^' Ten months following the

amended order, the estate petitioned for a reduction of the penalty

interest from ten percent to ten percent pursuant to Indiana Code section

6-4.1-9-l(b),^^ which permits the probate court to grant a reduction if an

unavoidable delay prevented the determination of the amount of the

inheritance tax due.

The probate court granted the estate's request for reduction." The

Department of Revenue objected to this reduction in interest on one

ground; it claimed that the petition requesting the reduction in interest

rate was not filed within the ninety day period required by statute^"* for

filing a petition for rehearing with a probate court after the determination

of an inheritance tax has been made."

The court of appeals held that a petition for reduction of interest

is within the ambit of the ninety day requirement for filing and that

failure to file within the statutory period deprived the probate court of

subject matter jurisdiction over the reduction in interest. ^^ The court

addressed the issue of whether or not the statute containing the ninety

day restriction for objecting to an "inheritance tax determination" in-

cludes a petition for the reduction of interest. ^^ The term "determination"

was held to mean consideration by the court of any factor relating to

^"Indiana Code section 6-4. 1-9- 1(a) provides that if the tax remains unpaid eighteen
months after the decedent's death, then a 10% interest rate is imposed on the delinquent
portion of the tax from the date of death until the payment is made. Ind. Code § 6-
4.1-9-1 (1982).

"457 N.E.2d at 251.

"Indiana Code section 6-4.1-9-l(b) provides:

If an unavoidable delay, such as necessary litigation, prevents a determination

of the amount of inheritance due, the appropriate probate court, in the case

of a resident decedent, or the department of state revenue, in the case of a

non-resident decedent, may reduce the rate of interest imposed under this section,
for the time period beginning on the date of the decedent's death and ending

when the cause of delay is removed, to six percent (6%) per year.
Ind. Code § 6-4.1-9-l(b) (1982).

"457 N.E.2d at 252.

'"•Indiana Code section § 6-4.1-7-1 provides:
A person who is dissatisfied with an inheritance tax determination made

by a probate court with respect to a resident decedent's estate may obtain a
rehearing on the determination. To obtain the rehearing, the person must file
a petition for rehearing with the probate court within ninety (90) days after the

determination is made. In the petition, the person must state the grounds for

the rehearing. The probate court shall base the rehearing on evidence presented
at the original hearing plus any additional evidence which the court elects to

hear.

Ind. Code § 6-4.1-7-1 (1982).
«457 N.E.2d at 252.

'"Id. at 253.

''Id. at 252.



1 985] SUR VEY—TAXA TION 397

the manner of which the amount of tax is ultimately computed, including

an interest reduction. ^^

The court observed that the order of the probate court granting the

reduction in interest was not restricted to that period prior to the final

determination of the tax.^^ While the court noted this conclusion was

incorrect because the statutory language^° permits reduction in interest

for only that period prior to the determination of the tax and not for

the period after the determination of tax and before payment, it indicated

that this error alone was not fatal and could have been modified upon
appeal.^'

In Indiana Department of State Revenue v. Estate of Rogers,^^ the

inheritance tax had been paid within one year of the decedent's death

but additional inheritance taxes, along with interest at the statutory rate

of ten percent per annum, were later determined after a federal estate tax

audit." The estate immediately paid an amount equal to the additional

inheritance tax determined to be due. The estate also filed a petition

to determine the interest due on this additional inheritance tax and for

a reduction of the interest rate from ten percent to six percent. ^"^ The

probate court ordered the estate to pay interest on the additional in-

heritance tax at a rate of ten percent from the date of the decedent's

death until the tax was finally paid.^^ Based upon this order, the estate

computed and paid the interest. In computing interest due, the estate

assumed that its first additional payment was applied first against the prin-

cipal of the tax due and any remainder constituted interest on the tax.^^

The probate court ultimately determined that the estate had properly

calculated the application of the payment to principal and interest.

Further, it found that the Department of Revenue, having failed to file

objections to the court's later order which confirmed the estate's cal-

culations, had waived its right to file objections because of the statutory

ninety day limitations^ on filing petitions for the redetermination of tax.^^

''Id. at 253 (citing In re Estate of Hogg, 150 Ind. App. 650, 276 N.E.2d 898 (1971)).

The court noted that the Hogg decision was based upon the pertinent statute prior to its
current amendment; however, the court found the Hogg analysis retained its applicability
in the setting of the existing case. 457 N.E.2d at 252-53.

^"457 N.E.2d at 252.

''°The pertinent portion of Indiana Code section § 6-4.1-9-l(b) provides: "[T]he

appropriate probate court . . . may reduce the rate of interest imposed under this section,
for the time period beginning on the date of the decedent's death and ending when the

cause of delay is removed . . . ." Ind. Code § 6-4.1-9-l(a) (1982) (emphasis added).
'^'457 N.E.2d at 252.

^M59 N.E.2d 69 (Ind. Ct. App. 1984).

''Id. at 70.

"^Id.

''Id.

''Id.

'''See supra note 54.

^«459 N.E.2d at 70.



398 INDIANA LAW REVIEW [Vol. 18:389

On appeal, the Department of Revenue contended that the later
payments of tax should have been first applied to interest due at the

time of payment and that any remainder should have been applied to

the principal of the inheritance tax due. It also claimed that since its

motion was in the nature of a motion to compel compliance with the

court's original determination of tax, its failure to file within the ninety

day period did not deprive the court of subject matter jurisdiction. It

argued that the motion was not within the realm of the statute limiting

the time for filing a petition for rehearing and redetermination of

inheritance tax.^*^

The court agreed with the Department of Revenue that payments

made when both inheritance tax and interest are due must be applied

first to the interest due, and then only after full payment of the interest

is applied, to the principal of the tax due.^" The Department of Revenue's

interpretation followed the laws of Indiana and the United States, which

generally require payments made without an agreement or statute to the

contrary be first applied to interest; then, if any remains, to the reduction

of principal.''

The court also held that the Department of Revenue's motion to

compel compHance with the court's original redetermination of additional

inheritance tax did not come within the ninety day requirement for filing.
This was so because the statute is limited in its application to those

cases where the Department of Revenue is ''dissatisfied with the inheri-

tance tax determination."^^

The court also quickly disposed of the estate's argument that an

oral agreement estopped the Department. The court held that since there

was no evidence of an oral agreement in the record there was no need

to consider whether an estoppel could even be asserted against the

Department. ^^

Whether or not the mailing of an inheritance tax payment by United

States certified mail, return receipt requested, two days prior to the due

date constituted a timely payment of inheritance tax was the question

posed to the court in Nell v. Tracy. '^'^ The facts in Nell were undisputed.

Two days prior to the due date of the inheritance tax, the estate's
attorney sent a check by certified mail, return receipt requested, in the

correct amount of tax due and payable, to the Indiana Department of

''Id.

'"Id. at 70-71 (citing 45 Ind. Admin. Code 4-6-6 (1984); 1962 Op. Att'y Gen. No.
73, 79).

^'459 N.E.2d at 71 (citing Jacobs v. Ballenger, 130 Ind. 231, 29 N.E. 782 (1892)
among many other authorities).

^M59 N.E.2d at 71.

''Id. at 72.

M59 N.E.2d 432 (Ind. Ct. App. 1984).



1 985] SUR VEY—TAXA TION 399

State Revenue at its proper address and to the proper person. ^^ The

check was mailed from the United States Post Office in Vincennes,

Indiana. According to the testimony of the postmaster of the Vincennes

Post Office, a letter mailed in such a manner would normally be delivered

overnight to the proper address in Indianapolis. The check was not
received until four days past the due date.^^ The Department of Revenue

contended payment was not timely, causing interest charges to accrue

from the date of decedent's death until the time of payment. ^^

The Inheritance Tax Division argued that the post office was the

agent of the sender because it could withdraw the letter prior to delivery

and, therefore, it was not until delivery that the payment was made.^^

The evidence in Nell did establish that the estate could have withdrawn

the payment from the mail but, nonetheless, the court held that payment

was made upon mailing.
The court relied upon decisions from other jurisdictions^*^ for the

proposition that the purpose of penalties upon late payment of tax was

to penalize those who were careless in their payment of tax and that
the penalty should not be imposed where persons mailed taxes in a

manner which would normally result in a timely payment. ^^ The estate

had done what any reasonable person in normal business practice would

have done, which was to make timely payment of the tax on or before
the due date.^' The court concluded that the Department of Revenue's

position was grossly unfair and wrong, dictating a finding in favor of

the estate. ^^ The holding in Nell prevents an unjust result to a taxpayer

which, as the court noted, could have done little more to ensure timely
payment short of personal delivery.

Another Indiana appellate court, in considering whether the filing

''Id. at 433.

''Id.

''Id. at 433 n.4. The Department of Revenue contended that based upon the holding in

Estate of Rogers, see supra notes 62-73 and accompanying text, the payment would be

applied first against interest due and the remaining against principal. Application of the

Rogers decision would have resulted in a sizeable sum of unpaid principal of inheritance

tax which would have drawn interest pending the outcome of the ultimate determination

of the timeliness of the payment.

78459 N.E.2d at 434 (citing Guardian Nat'l Bank v. Huntington County State Bank,

206 Ind. 185, 187 N.E. 388 (1933)).

'M59 N.E.2d at 434. The court first cited Hills Materials Co., Inc. v. Van Johnson,

316 N.W.2d 646 (S.D. 1982), which permitted a taxpayer to go unpenalized when he was

able to establish he had mailed his tax payment three days prior to the due date. The

second case cited by the court for this proposition was General Petroleum Corp. v. Smith,

62 Ariz. 239, 157 P. 2d 356 (1945).
'^0459 N.E. 2d at 434.

'Ud. at 435.



400 INDIANA LAW REVIEW [Vol. 18:389

of an appeal of property tax assessment was timely, has recently reached

a different conclusion about the effect of filing by mail.^^ This may

indicate that a decision from the Indiana Supreme Court would be

appropriate to resolve this conflict between the appellate courts, or that

the imposition of a penalty deserves a special exception in the law. In

either case, the interests of Indiana taxpayers would be best served by

a statutory enactment. A more favorable solution would be a statute
which prescribes that the mailing of these items would be effective at

the date of the postmark. This would comport with an endless list of

statutes and trial rules which permit federal and state tax payments and

pleadings regarding tax matters to be effective upon proper mailing with

the United States Post Office. Moreover, effectiveness upon mailing
offers a desirable certainty which is not otherwise practically obtainable.

In Indiana Department of State Revenue v. Estate of Smith,^"^ the

question was whether or not the survivor of the decedent was entitled

to a deduction, for inheritance tax purposes, for payment of the de-

cedent's funeral expenses and the estate's administrative expenses. ^^ The

survivor and the decedent were joint tenants with full rights of survi-

vorship to a bank account. Indiana's statute^^ does not permit deductions

for payment by a survivor of a joint bank account if the assets of the

decedent's estate are sufficient to pay the debts or funeral expenses.

The value of the assets in the estate were sufficient to pay these expenses,

but were not used because the assets were not readily convertible into

an acceptable form of payment for these expenses. ^^

The court held that the payments by the holder of a joint survivor

account could not be claimed as deductions simply because the estate

lacked the liquidity to make the payments eventually made by the joint
survivor. Because the statute was clear and unambiguous, the court could

not substitute language which it felt the legislature may have intended. ^^

D. Property Tax

In Margrat, Inc. v. Indiana State Board of Tax Commissioners,^^

''See Margrat, Inc. v. Indiana State Bd. of Tax Comm'rs, 448 N.E.2d 684 (Ind.

Ct. App. 1982). See infra notes 89-99 and accompanying text.

«M60 N.E.2d 1263 (Ind. Ct. App. 1984).

''Id. at 1264.

^^Indiana Code section 6-4.1-3-14 provides in pertinent part: "[T]he amount of the

decedent's debts or funeral expenses paid by a surviving joint owner of property held

jointly with the decedent may be deducted from the value of the jointly held property
if the assets of decedent's estate are insufficient to pay the debts or funeral expenses."

Ind. Code § 6-4.1-3-14 (1982).
«M60 N.E.2d at 1265.

''Id. (citing State ex rel. Southern Hills Mental Health Center, Inc. v. Dubois County,

446 N.E.2d 996 (Ind. Ct. App. 1983)).
«M48 N.E.2d 684 (Ind. Ct. App. 1982).



1 985] SUR VEY—TAXA TION 401

a taxpayer received an adverse determination by the State Board of Tax

Commissioners regarding the assessed value of the taxpayer's property.

The taxpayer mailed its notice of appeal by registered mail, return receipt

requested, exactly thirty days following the date of the adverse deter-

mination. Three days later the State Board received the notice of intent

to appeal. ^° The State Board moved to dismiss this appeal on the ground
that the notice had not been filed within the thirty day statutory re-

quirement for filing.^'

An appeal from the State Board of Tax Commissioners is permitted
by statute^^ if written notice is made within thirty days after the board
gives notice of its final determination to the taxpayer. '^^ The statute also

expressly provides that notice is effected upon the taxpayer on the day

on which the notice is deposited in the United States mail.^'*

In Margrat, the court rejected the taxpayer's argument that the

Indiana Trial Rules should be applied to make a filing effective upon
mailing by registered or certified mail and to add three days to a

prescribed period when notice is mailed to a party. ^^ Instead, the court
found Weatherhead Co. v. State Board of Tax Commissioners'^^ con-

trolling which interpreted the predecessor statute to the current provision

for the filing of written notice with the Board. ^^ In Weatherhead, the

court found that the term "filing" meant the actual delivery of the

document to the proper office and its receipt by the proper official. '^^

Since the language of the existing statute had not been changed in

meaning from that interpreted in Weatherhead, the court held that notice

of an appeal of a determination by the Board must be received within

the thirty day period in order to be an effective notice of an appeal. "^^

'"M at 685.

"'Indiana Code section 6-1.1-15-5 provides in pertinent part:

(b) If a person desires to initiate an appeal of the state of board of tax

commissioners' final determination, he shall:

(1) file a written notice with the state board of tax commissioners

informing the board of his intention to appeal . . .;

(c) To initiate an appeal under this section a person must take the action

required by subsection (b) of this section within thirty (30) days after

the board gives him notice of its final determination.

IND. Code § 6-1.1-15-5 (1982).
'H48 N.E.2d at 685.

"^IND. Code § 6-1.1-36-1 (1982).
"H48 N.E.2d at 685.

^151 Ind. App. 680, 281 N.E.2d 547 (1972).

'M48 N.E.2d at 685.

''"Id. at 686 (citing Weatherhead, 151 Ind. App. at 684, 281 N.E.2d at 550).

^H48 N.E.2d at 686.



402 INDIANA LAW REVIEW [Vol. 18:389

E. Sales Tax

The Supreme Court of Indiana settled much of the confusion sur-
rounding the interpretation of the "double direct" language contained

within the sales tax exemption in its decisions in Indiana Department

of State Revenue v. Cave Stone, Inc. and Indiana Department of State

Revenue v. Meshberger Stone, Inc.^^^ This language provides for a sales

tax exemption for the purchase of certain equipment "to be directly

used by the purchaser in the direct production . . . of . . . tangible

personal property."'"' In Cave Stone, the court considered the purchase

of equipment which was used to transport stone from quarry to crusher

and from crusher to stockpiles. The supreme court held that this equip-

ment was "directly used" in the "direct production" of the companies'

stone product and was thereby exempt from the gross retail tax, or sales

tax. The supreme court accepted transfer of these cases in order to

resolve the conflict in interpretation of the statute.'"^

The case arose upon separate complaints filed by Cave Stone, Inc.

and Meshberger Stone, Inc. (the "Companies"). The supreme court

found the issues in both cases to be identical and having been treated

as such in one appeal, it considered them together in its single decision.

Only one issue '^^ was considered and resolved by the supreme court:

whether or not the machinery, parts, and related items used by the Com-
panies in hauling crude stone were directly used by the Companies in the

direct production, manufacture, mining, processing, or finishing of tangi-

ble personal property.
'""^

The Companies were in the business of selling sized, aggregate stone

after its removal from their quarries. The preparation of the stone for

sale involved several processes. The crude stone was stripped, drilled,

blasted, and then loaded onto trucks which hauled it to a primary

crusher. The stone was then crushed, separated, washed, and screened

into various grades of aggregate stone. The stone was next taken by
conveyor to a loader for loading onto trucks for transport to separate

stockpiles, referred to as "stock out," from which it was eventually

sold. The stockpiling not only preserved the grading of the stone and
prevented commingling, but also allowed moisture to drain from the

"M57 N.E.2d 520 (Ind. 1983). Because these two cases were combined by the Indiana

Supreme Court and decided upon the basis of the same issue, both are referred to when

the case name ''Cave Stone'' is used.
""Ind. Code § 6-2-1 -39(b)(6) (1976) (recodified at Ind. Code § 6-2.5-5-3 (1982)

(emphasis added)).

'"^For a more complete discussion of this controversy, see King, Taxation, 1981 Survey

of Recent Developments in Indiana Law, 15 Ind. L. Rev. 409, 413 (1982).

'°'A second issue presented for determination was whether or not the Companies

were subject to penalties. Due to the ultimate disposition of this case, it was not necessary
to decide this issue. 457 N.E.2d at 527.

"^M at 521.



1985] SUR VEY—TAXA TION 403

washed stone to obtain a moisture level at a standard generally acceptable

to stone purchasers. '^^ The trial court found that the transportation of

the materials prior to their final disposition in stock out was prior to

the stone being in its "final, most marketable form" because the stock

out step also constituted a part of the production, the necessary drainage

of the stockpiles. '^^ The trial court also concluded the stock out step

constituted transportation of unfinished work, a part of the continuous

flow of the production of the stone. '^^

Section 6-2-1 -39(b)(6) of the Indiana Code which was the pertinent
statute for the years in controversy provided in part: "Nor shall the
state gross retail tax [sales tax] apply to any of the following transactions:

.... Sales of manufacturing machinery, tools and equipment to be
directly used by the purchaser in the direct production, manufacture,

fabrication, assembly, extraction, mining, processing, refining or finishing

of tangible personal property. . . ."'°^ The court of appeals, in arriving

at its decision against the taxpayer, had concluded that the various

categories contained in the above statute were exclusive of one another

and that "to the extent a particular procedure falls within a definite

exemption category that category is exclusive. . . .'"^ The majority of
the appellate court then found that the appropriate category in the case

at bar was the term "processing," which requires an operation placing

the product in a different form, composition, or character. Next, the

majority found that because the hauling of the crude stone and the

stock out were steps which did not alter the form, composition, or

character of the stone, these were steps not directly used in the direct

processing of the stone. '^^ Upon rehearing, the court of appeals also
determined that the equipment was not used in the direct "production"

of stone. Further, to be exempt from the sales tax the manufacture and

equipment would have to have a transformational effect as opposed to

a translational effect.' '^

In Cave Stone, the supreme court recognized that exemption statutes

were to be strictly construed against the taxpayer,''^ but found that the

"^Id. at 523.

"»lND. Code § 6-2-1 -39(b)(6) (1976) (recodified at Ind. Code § 6-2.5-5-3 (1982)).
"^457 N.E.2d at 524 (quoting Indiana Dep't of State Revenue v. Cave Stone, Inc.;

Indiana Dep't of State Revenue v. Meshberger Stone, Inc., 409 N.E.2d 690, 695 (Ind.

Ct. App. 1980), vacated, 457 N.E.2d 520 (Ind. 1983)).

"'/6/. (citing Gross Income Tax Div. v. National Bank & Trust Co., 226 Ind. 293,
298, 79 N.E.2d 651, 653 (1948); Conklin v. Town of Cambridge City, 58 Ind. 130, 133
(1877)).



404 INDIANA LAW REVIEW [Vol. 18:389

court of appeals had too narrowly construed this statute against the

taxpayer. Specifically, the supreme court found that the exemption pro-

visions were not mutually exclusive but provided a comprehensive de-

scription of various means of "production.""^ The supreme court cited

with approval Judge Buchanan's dissent in the appellate court decision

in which he provided two definitions of "production."'"* The supreme

court concluded that the statute envisioned all of the operations or

processes by which the finished product was derived. Thus, the supreme

court reasoned that the production or processing of stone begins at the

time of the initial stripping, drilling, and blasting at the quarry and

ends at the time the stone is stockpiled. Further, the production process

was continuous and indivisible."^

The supreme court found that the transportation in question was

"essential to the achievement of a transformation of the crude stone

into aggregate stone" and that it "played an integral part in the ongoing

process of transformation.""^ Therefore, the supreme court held that

the equipment was directly used by the Companies in direct production,

manufacturing, mining, processing, or finishing of tangible personal

property within the meaning of the exemption."^

In the course of explaining its reasoning, the supreme court defined

the term "direct" production: "direct" production turned on whether

or not the transportation was an integral element in the production or

processing of the aggregate stone. It did not matter whether any trans-

formation occurred during the transportation of the stone; rather, because

the trucks were "essential to the achievement of a transformation of

the crude stone into aggregate stone," the equipment was used in the

direct production."^

"H57 N.E.2d at 524.

"'/cf. The definitions of the word production cited by Chief Judge Buchanan and

incorporated in Cave Stone were the following:

'"In an economic sense, production includes all activity directed to increasing

the number of scarce economic goods. It is not simply the manual, physical

labor involved in changing the form or utility of a tangible article. . . . Production:

something that is produced naturally or as a result of labor and effort; the act

or process of producing, bringing forth or making; the creation of utility, the

making of goods available for human wants.'"
Id. (quoting Indiana Dep't of State Revenue v. Cave Stone, Inc.; Indiana Dep't of State

Revenue v. Meshberger Stone, Inc., 409 N.E.2d 690, 698 (Ind. Ct. App. 1980) (Buchanan,

C.J., concurring in part and dissenting in part) (quoting Borden Co. v. Borella, 325 U.S.

679, 683 (1945); Webster's TmRD Law Int'l Dictionary 1810 (unabridged ed. 1971),
Cave Stone vacated, 457 N.E.2d 520 (Ind. 1983)).

"M57 N.E.2d at 527.
'''Id.

'"Id.

'"Id.



1985] SURVEY—TAXATION ' 405

While the supreme court spent much time defining and explaining
the term ''direct production," it gave only a cursory review to the pharse

"directly used by the purchasers":

The statute provides that the manufacturing machinery, tools
and equipment, in order to be exempt, must (1) be directly used

by the purchaser and (2) be used in the direct production,

manufacture, fabrication, assembly, extraction, mining, process-

ing, refining or finishing of tangible personal property. In the

present case, the transportation equipment in question was di-

rectly used by the purchaser, not some other entity, and it was
used in the direct production and processing of crude stone into

aggregate stoneJ '^

The supreme court appears to have changed the "double direct" test

to a single direct test by defining "directly used by the purchaser" as

used by the purchaser and "not some other entity."
The court followed its conclusion with a review of the various Indiana

appellate court decisions which have interpreted this exemption. ^^^ A
look at each of these cases reviewed by the Indiana Supreme Court is
instructive because it indicates the supreme court's analysis in other

factual settings.

One case discussed in Cave Stone was Department of Revenue v.
United States Steel Corp.^^^ The court found the United States Steel

analysis was correct in interpreting that "direct" production requires the

equipment in question to have an "'immediate link with the product

being produced. "''^^ The supreme court also noted that the United States

Steel analysis correctly concluded that the focus should be on whether

the equipment was an '"integral part of manufacturing and operates

directly on the product during production. "'^^3 jj^^ supreme court stated

that it had been held in United States Steel that safety equipment was

essential, integral, and in direct production, for the employees could not

complete the production process without the equipment. ^^4

The court in Cave Stone also affirmed the analysis in Indiana

Department of State Revenue v. American Dairy of Evansville, Inc.^^^

In American Dairy it was held that milk cans used to hold, measure,

and convey raw materials were available for exemption from the sales

"'M at 525 (emphasis added).
•^°M at 525-26

'^'425 N.E.2d 659 (Ind. Ct. App. 1981).
'^^57 N.E.2d at 525 (quoting Department of Revenue v. United States Steel Corp.,

425 N.E.2d 659, 662 (Ind. Ct. App. 1981)).
'"457 N.E.2d at 525 (quoting Department of Revenue v. United States Steel Corp.,

425 N.E.2d 659, 664 (Ind. Ct. App. 1981)).

'M57 N.E.2d at 525.
•^167 Ind. App. 367, 338 N.E.2d 698 (1975), transfer denied, July 14, 1976.



406 INDIANA LAW REVIEW [Vol. 18:389

tax.'^^ In Cave Stone, the supreme court stated that the majority of the

appellate court had incorrectly distinguished American Dairy on the

ground that the processing of the milk occurred while the milk was in

the cans while no processing of the stone occurred during transport in

Cave Stone. ^^^ The supreme court noted that the trial court in American

Dairy had found that the containers were used only to "hold, measure

and convey. "'^^ It was further noted that the court of appeals in American

Dairy had permitted the exemption for the milk containers without

requiring any transformation in the milk while stored in the containers. '^^

The holding in Indiana Department of State Revenue v. RCA Corp.^^^
was also found to be consistent with the holding in Cave Stone. The

court in RCA held that air conditioning equipment in an RCA plant
was not directly used in direct production of color television picture

tubes. The court recognized the importance of the air conditioning to

the production, but found that the production could continue without

the air conditioning even though it would be done in a less economic

manner. This was found to be distinguishable from Cave Stone in which

the equipment to transport the stone to the crusher and to the stockpiles

was essential to the production of the aggregate stone. '^' The supreme

court did not address the fact that in RCA the Department of Revenue
had conceded that the controlled environment was "integral and essen-

tial" to RCA,'^^ which suggests that RCA may have been closer to an
exemption than the supreme court admitted.

The supreme court also concluded that its instant opinion was con-
sistent with the holding in Indiana Department of State Revenue v.

Harrison Steel Castings Co.^^^ In Harrison, safety equipment was found

not to be ehgible for the sales tax exemption because, according to the

supreme court, it was not so essential to the production that its removal

would have halted production.'^"*

In Cave Stone, the court also addressed the effect of the Department's

regulations. The Department of Revenue argued that a different result

might have occurred had this case been brought under the later, and

now existing, regulations. The supreme court, however, clearly stated that

''"Id. at 375, 338 N.E.2d at 702.
'"457 N.E.2d at 526.

''"Id.

""160 Ind. App. 55, 310 N.E.2d 96 (1974), transfer denied, Oct. 13, 1976.

'^'457 N.E.2d at 526.

"460 Ind. App. at 58, 310 N.E.2d at 98.
'"402 N.E.2d 1276 (Ind. Ct. App. 1980).

'^M57 N.E.2d at 526.



1985] SURVEY—TAXATION 407

to the extent any regulation was inconsistent with the holding in Cave

Stone, it would be contrary to the enabling statute and invalid to that

extent. '^^ Therefore, it appears quite clear that Cave Stone is, and will

continue to be, the seminal case in the field of exemption from sales

tax for the purchase of equipment to be directly used by the purchaser

in the direct production of tangible personal property in Indiana.

Nevertheless, Cave Stone will not end the search for a test which

will clearly identify equipment used in "direct" production, as there will

continue to be an endless need for application of whether an item

constitutes "an integral and essential part of production." Rather, the

great importance of Cave Stone is that it has decisively put to rest the

Department's argument that to qualify for the sales tax exemption an

item must actually touch or have a direct positive effect upon the item

produced.

In Indiana Department of State Revenue v. Hertz Corp.,^^^ Hertz

sought an exemption from the sales tax for its gasoline purchases. Hertz

claimed that the purchase of that portion of its gasoline which it sold

to its customers was not subject to sales tax because its purchase was

a wholesale purchase for resale to its customers, '^^ and because it was

a purchase for the purpose of reselling the same goods in the form in

which they were purchased. '^^

Hertz established that it generally entered into two types of rental

agreements. The first type of agreement was a "wet rental" agreement

in which all the fuel was provided by Hertz and a higher charge was

paid by the customer because the fuel was provided. Under the "wet

rental" agreements, the entire price of the rental was subjected to sales

'''Id. at 527.

'M57 N.E.2d 246 (Ind. Ct. App. 1983).

'"The previous code section provided: "The term 'wholesale sales' means and includes

only the following: (1) Sales of any tangible personal property ... to a purchaser who
purchases the same for the purpose of reselling it in the form in which it is sold to him

. . .
." Ind. Code § 6-2-l-3(a) (1976) (recodified at Ind. Code § 6-2.5-4-2(b) (1982)).

This provision is now found at Indiana Code section 6-2.5-4-2(b) which provides, for

purposes of this discussion, that a person is making wholesale sales when he "(1) sells

tangible personal property, other than capital assets or depreciable property, to a person

who purchases the property for the purpose of reselling it without changing its form."
Ind. Code § 6-2.5-4-2(b) (1982)

"*'The previous code section provided: "(b) Nor shall the state gross retail tax [sales

tax] apply to . . . (9) Sales of any tangible personal property to a purchaser who purchases
the same for the purpose of reselling in the regular course of the purchaser's business

such tangible personal property in the form in which it is sold to such purchaser." Ind.

Code § 6-2-1 -39(b)(9) (1976) (recodified in Ind. Code § 6-2.5-5-8 (1982)). This provision
is now included at Indiana Code section 6-2.5-5-8: "Transactions involving tangible personal
property are exempt from the state gross retail tax [sales tax] if the person acquiring the

property acquires it for resale, rental, or leasing in the ordinary course of his business

without changing the form of the property." Ind. Code § 6-2.5-5-8 (1982).



408 INDIANA LAW REVIEW [Vol. 18:389

tax which was collected and remitted to the Department of Revenue. '^^

The second type of rental agreement used by Hertz was a "dry rental"

agreement, in which the customer was required to pay Hertz if the

vehicle were returned to Hertz with less than a full tank of gasoline. In

the case of these "dry rental" agreements, the bill to the customer

would segregate his charge into two separate categories: the additional

charge for the fact that the car had been returned with less than a full

tank of gasoline, and the normal rental charge based upon the mileage

and time of the rental of the vehicle. Sales tax was collected on both

categories of the customer's bill and timely remitted to the Department

of Revenue. "*°

Hertz objected only to the collection of sales tax upon its bulk

purchases of fuel which in turn were used by its customers under both

the dry and wet rental agreements. The court agreed with Hertz that

its customers had separately paid for the gasoline supplied by Hertz by

either the higher charge placed on them in the case of "wet rental"

agreements or by a separate charge in the case of ''dry rental"

agreements. •'*• This qualified the bulk purchase of gasoline by Hertz as

an exempt purchase under the statutory exemption of purchases for

resales. '"^^ Although Hertz suggested several alternatives to support its

argument, the court relied solely upon this exemption and did not consider

the adequacy of other arguments. "^^

In Indiana Department of State Revenue v. Indiana Harbor Belt

Railroad, ^"^"^ the court of appeals interpreted the sales tax exemption

containing the so-called "single-direct" standard. '"^^ In Harbor Belt, the

railroad argued that the purchase of the following items were exempt

from the sales tax by virtue of being directly used or consumed for the

rendering of pubhc transportation: tools and equipment used to repair

and maintain rolHng stock and track; items used for repair and main-

tenance of the railroad's buildings; vehicles (other than locomotives or

rolling stock) used primarily for transportation of track maintenance

crews; items used for repairs and maintenance of those vehicles; and

'"457 N.E.2d at 247.

'^'M at 249-50.

'*^lND. Code § 6-2-1 -39(b)(9) (1976) (recodified at Ind. Code § 6-2.5-5-8 (1982)). See

supra note 138.

'«457 N.E.2d at 247.

'M60 N.E.2d 170 (Ind. Ct. App. 1984).

'"The former relevant Indiana Code section provided the following exception from

sales tax: "The sale, storage, use or other consumption in this state of tangible personal

property or service which is directly used or consumed in the rendering of public trans-

portation of persons or property." Ind. Code § 6-2-1 -39(b)(4) (1976) (recodified at Ind.

Code § 6-2.5-5-27 (1982)). The current code provides the following exemption: "Trans-

actions involving tangible personal property and services are exempt from the state gross

retail tax [sales tax], if the person acquiring the property or service directly uses or



1985] SURVEY—TAXATION 409

items used in general administrative and managerial operations such as

office equipment, uniforms, and locks and keys."*^

While the court recognized the literal distinction between the "single-

direct" standard contained in the law in issue, it indicated that the

holding by the Indiana Supreme Court in Cave Stone^'^'^ adopted a test

which did not require a reference to the single or double directness

language of the statutes. The court in Harbor Belt interpreted Cave

Stone as necessitating an examination of the integrated process of manu-

facturing and establishing an "immediate link with the product being

produced. '""^^ Further, the holding in Cave Stone was found applicable

to the statute containing the "single-direct" standard by analogy.'"*^ The

court stated that the test to be applied, based on Cave Stone, is to

consider the "particular item's relation to full, continuous and indivisible

production process, not whether an item . . . has a transformational

effect on the end product. "'^°

The only previous Indiana case interpreting the "single-direct" re-

quirement in controversy was Indiana Department of State Revenue v.

Indianapolis Transit System, Inc.^^^ In Indianapolis Transit, the court

applied the test of whether the purchased items had a "necessity towards

operations. "^^^ The court in Harbor Belt felt that this approach by the

court in Indianapolis Transit did not vary much, if at all, from the

approach adopted in Cave Stone. ^^^ The only difference the court noted

between the cases was the distinction between what is an integral part

of manufacturing as compared to what is an integral part of rendering

transportation. The court noted that the latter concept, "an integral

part of rendering transportation," was a broader concept.'^"*

The Harbor Belt court went on to find that all of the contested
items were exempt from the sales tax under the reasoning enunciated

in Cave Stone. ^^^ These were found to be within the concept of a "direct

use or consumption in the integrated operation of providing public

transportation. "'^^

consumes it in providing public transportation for persons or property." Ind. Code § 6-
2.5-5-27 (1982).

'M60 N.E.2d at 176.
'^M57 N.E.2d 520 (Ind. 1983).

'M60 N.E.2d at 174 (quoting Department of Revenue v. United States Steel Corp.,
425 N.E.2d 659, 662 (Ind. Ct. App. 1981)).

'^^60 N.E.2d at 175.

'^°M (citing Cave Stone, 457 N.E.2d at 524).
'='171 Ind. App. 299, 356 N.E.2d 1204 (1976).
'"M at 306, 356 N.E.2d at 1209.
'"460 N.E.2d at 175.

'''Id.

'''Id. at 176-77.

'''Id.



410 INDIANA LAW REVIEW [Vol. 18:389

The court in Harbor Belt, while reviewing the standard set forth in

Cave Stone, did not apply the test to each of the specific items claimed

to be exempt by the railroad. Although the court claimed that each of

these items was within the holding of Cave Stone, it appears that the

court relied on its "broader concept" in interpreting what was "directly

used or consumed for the rendering of public transportation" in order

to find that purchases such as "repair and maintenance of buildings

and general administrative and managerial operations" were exempt.

Otherwise, it is impossible to imagine that such items would be exempt

under a Cave Stone analysis.

F. 1984 Statutory Developments in Indiana Tax Law

Several provisions of particular importance were adopted by the 1984

General Assembly. The four most significant statutory changes are in-
cluded in this Article.

1. Changes in Indiana Adjusted Gross Income Tax.—Section 6-3-1-
3.5 of the Indiana Code defines the term "adjusted gross income" to
mean the adjusted gross income as defined in the Internal Revenue Code,
as modified by other provisions in that section. '^^ One effect of this is
that changes made in the federal tax structure which affect an individual's
federal adjusted gross income will cause a corresponding change in the

individual's Indiana adjusted gross income. '^^ Such a change was brought

about in federal income tax law, and consequently in Indiana law, by

the Social Security Amendments of 1983.'^^

This change is contained in the Internal Revenue Code at section
86, which generally provides that beginning in 1984, individuals receiving
social security benefits and certain railroad retirement benefits may be
taxed for federal income tax purposes on a portion of those benefits,
depending upon their other income and tax return filing status.'^ As
indicated, since the Indiana adjusted gross income follows the federal

'"Ind. Code § 6-3-1-3.5 (Supp. 1984). This code section provides that "the term

'adjusted gross income' shall mean: (a) In the case of all individuals, 'adjusted gross

income' as defined in Section 62 of the Internal Revenue Code . . . ." Id.

'^«Act of Feb. 24, 1984, Pub. L. No. 49-1984, Sec. 2, 1984 Ind. Acts 621, 623

(codified at Ind. Code § 6-3-1-11 (Supp. 1984)) defined the term "Internal Revenue Code"

to mean the United States Internal Revenue Code of 1954 as amended and in effect on

January 1, 1984.

'^^Social Security Amendments of 1983, Pub. L. No. 98-21, 97 Stat. 65. (1983).
'^I.R.C. § 86(b) (West Supp. 1984). This section causes an inclusion of a portion of the

social security benefits based upon the taxpayer's federal adjusted gross income, with

certain modifications, but only to the extent these benefits exceed a "base amount."

Lower income taxpayers should not be affected by this provision because the "base

amount" provided in I.R.C. § 86(c) is $25,000, except in the case of taxpayers filing a

joint return , in which case the "base amount" is $32,000, and $-0- for taxpayers married

at the close of a taxable year not filing a joint return and not living apart from their

spouse at all times during the taxable year. Id.



1985] SURVEY—TAXA TION 4 1

1

adjusted gross income, those taxpayers subjected to federal income tax

on social security benefits would also include this amount in their Indiana

adjusted gross income if it were not for Public Law 49.'^' This provision
adds Indiana Code section 6-3-1-3. 5(a)(12), a reduction of Indiana ad-

justed gross income for that amount equal to the social security and

railroad retirement benefits included in the taxpayer's federal gross income

by reason of section 86 of the Internal Revenue Code. Thus, even those

selected taxpayers who will be subject to federal income tax due to social
security and railroad retirement benefits will not be subjected to Indiana

adjusted gross income tax on those amounts.

2. Exemption from the Indiana Gross Income Tax and Filing Re-
quirements for Certain Corporations.—With Public Law 78,'^^ the 1983
Indiana General Assembly made a major change by exempting certain
corporations from the Indiana gross income tax. This law is a significant

departure from the longstanding Indiana rule that all corporations, except

those qualifying as a federal S corporation, '^^ were subject to tax on

their gross income. For those qualifying corporations that are not federal

S corporations, this exemption only applies to gross income tax and

does not affect the corporation's requirement to pay Indiana adjusted

gross income and Indiana supplemental net income taxes.

The significance of this provision is that it will no longer be desirable

or necessary for corporations doing business in Indiana to elect to be

treated as federal S corporations solely in order to avoid paying the

gross income tax. Quahfying corporations may choose to revoke their
election to be treated as S corporations in order to gain the benefits

of income tax splitting between the corporate entity and the shareholders,

who would otherwise be taxed on the corporation's income if the S
corporation election were to be continued. In certain cases, the current

federal income tax savings of such income splitting may more than offset
the additional Indiana adjusted gross and supplemental net income taxes

imposed on the corporation. Furthermore, this gross income tax ex-

emption will remove one major tax disincentive for the incorporation

of partnerships and sole proprietorships, thereby subjecting the resulting

corporation to Indiana tax on its gross income.'^"*

The requirements to quaUfy under this exemption are nearly identical

"^'Act of Feb. 24, 1984, Pub. L. No. 49-1984, Sec. 1, 1984 Ind. Acts 621, 622

(codified at Ind. Code § 6-3-1-3.5 (Supp. 1984)).
'"^Act of Mar. 23, 1983, Pub. L. No. 78-1983, 1983 Ind. Acts 662 (codified at Ind.

Code § 6-2.1-3-24.5 (Supp. 1984)).
'"'See Ind. Code § 6-2.1-3-24 (1982); Ind. Code § 6-3-2-3 (1982) (exempting cor-

porations qualifying as federal S corporations from tax under the Indiana gross income
tax and Indiana adjusted gross income tax, respectively).

'"A more complete discussion of the effects of this Act is contained at Smith &
Hetzner, To incorporate or not to incorporate—after 'Indiana SBC Act'—, 27 Res Gestae
270 (1983).



412 INDIANA LAW REVIEW [Vol. 18:389

to the requirements for a corporation eligible to elect federal S corporation

treatment. In fact, the statute incorporates the term "small business

corporation" as having the same definition as that contained in the

Internal Revenue Code at section 1361. Generally, section 1361(b) requires
that, to be eligible as a "small business corporation," a corporation

must: (1) be a domestic corporation; (2) not be a member of an affiliated
group as defined therein, with one exception for inactive subsidiaries;

(3) have only one class of stock, with certain exceptions; (4) have not

more than thirty-five shareholders with husband and wife being treated
as one shareholder; and (5) have only shareholders that are United States

citizens or certain estates or trusts. '^^

An additional requirement to be eligible to qualify as an Indiana
small business corporation is included in section 6-2. 1-3-24. 5(c) of the

Indiana Code. This section requires a small business corporation to have

less than 25% of the corporation's gross income consist of passive
investment income in a taxable year.'^^ Generally, passive investment

income is defined to include royalties, rents, dividends, interest, annuities,

and gains from sales or exchanges of stocks and securities. '^^

Public Law 47'^^ amended section 6-2. 1-3-24. 5(d) of the Indiana Code
to specify when a corporation desiring to be exempt from Indiana gross

income tax must file proof with the Department of Revenue. The statute

now clearly provides that the corporation claiming the exemption must
annually provide proof to the Department of its eligibility for the ex-

emption. This proof must be filed on or before the due date of the

corporation's gross income tax return, including any extensions granted

by the Department of Revenue therefor. Both the exemption and the

proof requirement are effective for taxable years that begin after De-

cember 31, 1983.'^^

3. Exclusion of Corporate Partnerships from Liability for the Indiana
Gross Income Tax.—Public Law 47^^^ also contains provisions which
eliminate corporate partnerships from liability for Indiana gross income

tax. Prior to amendment, the exemption for partnerships from gross

income tax specifically excluded a partnership which had one or more

partners that were corporations. ^^^ Under the previous provisions of the

law, several questions had arisen and were litigated concerning the exact

'"I.R.C. § 1361(b) (West Supp. 1984).

'**The term "passive investment income" is, by incorporation, defined to have the

same meaning as contained at I.R.C. § 1362(d)(3)(D) (West Supp. 1984).

'''See id.

'^Acts of Mar. 5, 1984, Pub. L. No. 47-1984, 1984 Ind. Acts 617 (codified at Ind.

Code § 6-2.1-3-24.5(d) (Supp. 1984)).
'''''See id.. Sec. 8, at 619.

'^°IND. Code §§ 6-2.1-3-25, 6-3.1-3-1 (Supp. 1984).
'"Repealed were portions of Indiana Code section 6-2.1-3-25 (1982).



1985] SURVEY—TAXATION 413

application of the term "corporate partnership" and its result when an
otherwise exempt corporation was the corporate partner, and when mul-

titiered partnerships existed. '^^

The effect of this new law is particularly dramatic to limited part-
nerships formed and sold to the public as tax shelter investments. Almost

always, it is desirable for the general partner of the limited partnership

to be a corporation for two reasons: (1) to limit the liability of the

general partner to the corporate assets; and (2) to provide continuity to

the partnership since it would be dissolved under state law in the event

of the death, insanity, or bankruptcy of an individual general partner.

Indiana law prior to the decisions of Indiana Department of State Revenue

V. Glendale-Glenbrook Associates^^^ and Park 100 Development Co. v.

Indiana Department of State Revenue,^^^ which imposed the gross income

tax on each partner of a "corporate partnership," made it generally
unacceptable to have a corporate general partner, thus forcing an in-

dividual to be the general partner and accept the associated liabilities.

After the Glendale and Park 100 decisions, it was possible to have an

S corporation be the general partner without the imposition of gross

income tax on the partnership's income. The change in the law likely
will result in more general partners in limited partnerships being regular

corporations. '^^ All practitioners will still need to be careful in forming

these limited partnerships to respect the possibility of the Internal Revenue

''^See Indiana Dep't of Revenue v. Glendale-Glenbrook Assocs., 429 N.E.2d 217 (Ind.

1981); Park 100 Dev. Co. v. Indiana Dep't of State Revenue, 429 N.E.2d 220 (Ind. 1981).

A discussion of these cases is contained at Boyd, Taxation, 1982 Survey of Recent
Developments in Indiana Law, 16 Ind. L. Rev. 355, 364-66 (1983).

'^H29 N.E.2d 217 (Ind. 1981).

'M29 N.E.2d 220 (Ind. 1981).

'^The new law establishes that a corporate partnership will not be subject to gross

income tax; however, it does not explain how the gross income tax will be applied to

corporations which are partners of a corporate partnership. Under the "aggregate" theory

of partnerships where the partnership is not considered a separate entity, but merely an

aggregation of separate individuals or entities, the corporate partner would be treated as

receiving its proportionate amount of the gross receipts of the partnership. This would

impose a substantial accounting and reporting requirement upon corporate partnerships

and may lead to avoidance of corporate partnership structures similar to that experienced
under the repealed law. In many partnerships, it may be impossible to determine the
proportionate share of gross income of any partner, particularly partnership agreements

with special allocation provisions.

Alternatively, under the "entity" theory of partnerships where the partnership is

considered a separate entity, only actual distributions by the partnership to the corporate

partner would result in gross income tax liability. This would seem to reach a conclusion

which is appropriate given the concept of "gross income" contained in Indiana Code

section 6-2.1-l-2(a) which imposes gross income tax on the "gross receipts of a taxpayer."

Ind. Code § 6-2.1-l-2(a) (Supp. 1984). The largest and most obvious advantage to this
interpretation is that the corporate partner would be taxed on the "net" proceeds of the

partnership after tax deductions, a result which would not be permitted if the corporate

partner had directly received its share of the "gross receipts" of the business carried on



414 INDIANA LAW REVIEW [Vol. 18:389

Service reclassifying these partnerships as "associations" taxable as cor-

porations not as partnerships. '^^

4. Enactment of a County Option Income Tax.—As of July 1, 1984,
Public Law 44'^^ permits Indiana counties to have the option of adopting
either the County Adjusted Gross Income Tax ("CAGIT") or the County
Option Income Tax ("COIT"), -but not both. COIT was introduced by

by the partnership. This is precisely the type of avoidance of the gross income tax that

the repealed provision relating to corporate partnerships was designed to avert.

If actual distributions to the corporate partner are determinative as its gross receipts

subject to the gross income tax, this will provide a substantial opportunity for tax planning.

Arranging partnership distributions to fall in particular years would enable corporations

to delay gross income tax payments and diminish them to the extent distributions are

switched away from years where the gross income tax liability exceeds the adjusted gross

income tax liability. Further, the actual distributions may have no relationship to the
income of the partnership for the same taxable year. Finally, the partnership may choose
not to make any distributions at all, even though it is generating large amounts of income.

The most flagrant abuses of any of these advantages may lead to attacks by the Indiana
Department of Revenue based on the "substance over form" argument.

Another approach to this problem is to have the corporation report as gross income

its portion of the partnership net income just as it is reported for adjusted gross income

tax purposes. This would be the simplest answer to the aforementioned accounting and

timing dificulties because the same information is already required for reporting to the

corporate partner. This approach would also minimize the opportunity for tax avoidance

since the income would be taxed in the same year that it was generated. Unfortunately,

this approach completely ignores the wording and intent of the Gross Income Tax Act

unless a strained interpretation of the term "gross receipts" is accepted.

Further complicating this matter, and of no less importance, is the fact that the

receipt of gross income by a corporation is taxed at two substantially different rates for

the purpose of the gross income tax. The initial question which arises is whether the

nature of the activity for purposes of the applicable tax rate will be set at the partnership

or corporate level, which may again involve the application of the "aggregate" or "entity"
theory of partnerships. Presumably, whichever theory is followed will be the same theory

that is folloVed for purposes of determining at what level the gross receipts will be treated

as received by the corporation. An application of the statute would again seem to require
that actual receipt of distributions will control, which will make it nearly impossible to
define whether a distribution to a partner should be taxed at the higher or lower rate of

gross income tax. See Ind. Code §§ 6-2.1-2-4, -5 (1982). Since partnership gross receipts
will likely not be in the same amount and the same year as any actual distributions to

the corporate partner, there may be a requirement to establish a "tracing" of the nature
of any distributions. In most cases, this would be an accounting nightmare.

The lack of segregation of gross income between the separate rates may subject the
taxpayer to the provisions of Indiana Code section 6-2.1-2-7(c) which provides that a
taxpayer who fails to separate his gross income as required will have his "entire gross
income" subject to the higher rates. Ind. Code § 6-2.1-l-7(c) (1982).

The Indiana Department of Revenue, in Information Bulletin Number 31, dated
March, 1984, has acknowledged the elimination of the gross income tax on corporate

partnerships. It does not undertake to establish its interpretation of the proper application

of gross income tax to corporate partners. Hopefully, additional guidance will be forth-

coming on this question.

''"•See Treas. Reg. § 301.7701-2 (1983); see also Rev. Proc. 74-17, 1974-1 C.B. 438,

as modified for the requirements for obtaining an advance Private Letter Ruling.

'"Act of Mar. 7, 1984, Pub. L. No. 44-1984, 1984 Ind. Acts 563.



1985] SURVEY—TAXATION 415

this new law and permits adopting counties to initially tax county tax-

payers at a rate of .2% on their Indiana adjusted gross income. A
"county taxpayer" includes a resident of that county on January 1 of

the applicable calendar year or a person maintaining his principal place

of business or employment in that county on January 1 of the applicable

year and not residing on that same date in a county in which COIT
or CAGIT is in effect. '^«

COIT may be initially adopted at a rate of .2% on resident county
taxpayers, automatically rising .\% each year until it reaches a maximum
of .6%.'^^ After the rate has reached the .6% level, the county may
act to increase COIT by no more than .1% each year until it reaches
a maximum of 1%.'^° When COIT applies to nonresident taxpayers of
a county, the rate will at all times be one-fourth of the tax rate imposed

upon the resident county taxpayers. •^^

G. Unitary Taxation

Last year's Survey Article on Taxation '^^ reported the United States

Supreme Court decision in Container Corp. of America v. Franchise

Tax Board. ^^^ In Container, the Supreme Court gave state courts broad

authority to determine whether or not the income of corporations related

to a corporation doing business in their state was part of a "unitary

business" and thus subject to taxation in their state based on the state's

apportionment laws. The State of Indiana's application of Container

was set forth in Commissioner's Directive #10. '^"^ Directive Number 10
indicates that the Department of Revenue will not use combined income

tax reporting under the "unitary business" concept as a means to assess

additional tax, but will only use this for the fair reporting and reflection

of income attributable to Indiana when the standard three factor formula
clearly does not fairly reflect income. A special point is made that
Indiana should not be characterized as a "unitary state." In support

of this contention, the Department of Revenue indicates that approxi-

mately eighty taxpayers are filing combined Indiana adjusted gross income

tax and supplemental net income tax returns as unitary business eatities.

It is indicated that many of these are filing as unitary businesses due

''«lND. Code § 6-3.5-6-1 (Supp. 1984).
'""Id. § 6-3.5-6-8(b), (d).

'«°M § 6-3.5-6-9(a).

'''Id. § 6-3.5-6-8(e).

'^^King & Bennett, Taxation, 1983 Survey of Recent Developments in Indiana Law,
17 Ind. L. Rev. 319, 319 (1984).

'^^03 S. Ct. 2933 (1983). For an extensive discussion of this case, see Stuart & Williams,
Constitutional Considerations of State Taxation of Multinational Corporate Income: Before
and After Container Corporation of America v. Franchise Tax Board, 16 Ind. L. Rev.
783 (1983).

'^^Commissioner's Directive Number 10, February, 1984 (Indiana's position on the
United States Supreme Court decision in Container Corp. of America v. Franchise Tax

Board).



416 INDIANA LAW REVIEW [Vol. 18:389

to the request of the corporations and not due to Department require-

ments.

In a related announcement,'^^ Governor Orr stated that the only

time combined reporting will be required for taxpayers conducting unitary

businesses will be when there is evidence of a blatant attempt to avoid

Indiana taxes. He further stated that there were only about fifteen returns
being required and that those were the result of the standard three factor

formula not fairly reflecting income of the taxpayers. He also indicated
that Indiana will not adopt unitary reporting as a general poHcy because

of the potential adverse effect to Indiana's future economic growth. '^^

Apparently, one inducement in the publication of the Commissioner's

Directive and the Governor's letter was the hope that the Sony Cor-

poration might locate a new plant in Terre Haute, Indiana. '^^ This report

indicated that prior to Sony agreeing to place a large plant near Terre

Haute, Sony officials obtained commitments from Governor Orr and

bipartisan political support for an agreement to abohsh the unitary tax.

If these reports are correct, it appears that legislation to abolish the

unitary tax in Indiana will be a prime goal of the General Assembly

in its next session. Lacking this, the Commissioner's Directive and the

Governor's letter should reassure most taxpayers that they will not be

required to file unitary reports in Indiana. Nevertheless, the right of

Indiana to impose combined reporting when the three factor formula
does not "fairly reflect income" is clearly reserved. What constitutes a
fair reflection of income is something which could likely have a different

meaning to the Department of Revenue and to taxpayers with potential

liability under the unitary business concept.

"^Letter from Robert D. Orr, Governor of the State of Indiana (February 23, 1984).

'^^Id.

'^"Indianapolis Business Journal, June 18-24, 1984, at 13.