MacFarlane v. Utah Tax Commission

2006 UT 25
AMENDED OPINION
This opinion is subject to revision before final
publication in the Pacific Reporter.
IN THE SUPREME COURT OF THE STATE OF UTAH
----oo0oo----
James and Carol MacFarlane, Nos. 20040956
Bernard and Verbena Diamond, 20030949
Samuel and Sandra A. Hunter, 20030887
Jane A. Marquardt, Robert L. and
Annette Marquardt, Robert S. and
Kim Marquardt, Barbara B. Baker,
and William and Julia L. Reagan,
Plaintiffs and Appellees,
v.
F I L E D
Utah State Tax Commission,
Defendant and Appellant. April 28, 2006
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Fourth District, Provo
The Honorable Anthony W. Schofield
No. 040400010
Attorneys: Mark K. Buchi, Steven P. Young, Charles R. Brown,
Jennifer A. James, Roger O. Tew, Salt Lake City,
for appellees
Mark L. Shurtleff, Att’y Gen., Mark E. Wainwright,
Asst. Att’y Gen., for appellant
Carol B. Lear, Jean Welch Hill for amicus Utah State
Board of Education
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DURHAM, Chief Justice:
INTRODUCTION
¶1 This is a consolidated appeal of judgments of the
Fourth Judicial District Court and the Utah State Tax Commission.
The common issue is whether Utah Code section 59-10-106 allows
the taxpayers to claim a credit against their income taxes for
certain corporate franchise taxes paid to California and Texas by
the small businesses of which they were shareholders. The Tax
Commission argues that the franchise taxes are not included in
the category of taxes for which a credit is statutorily allowed.
We disagree.

1 Management Training Corporation was doing business in both
Texas and California, as well as other states; I.C. Printers was
doing business in California and other states, as was Challenger
Schools; Reagan National Advertising of Austin, Inc., was doing
business in Texas.
Nos. 20040956, 20030949, 20030887 2
BACKGROUND
¶2 Four sets of taxpayers are involved in this case. The
first party consists of Bernard and Verbena Diamond, Samuel and
Sandra A. Hunter, Jane A. Marquardt, Robert L. and Annette
Marquardt, and Robert S. and Kim Marquardt (collectively, the
“MTC Shareholders”), each of whom was a shareholder, or the
spouse of a shareholder, in Management and Training Corporation.
The second party consists of James and Carol MacFarlane, who were
the sole shareholders of I.C. Security Printers, Inc. The third
party, Barbara Baker, was the sole shareholder of Challenger
Schools. Finally, William Reagan, who with his wife forms the
last party, was the sole shareholder of Reagan National
Advertising of Austin, Inc. All of these individuals
(collectively, the “Taxpayers”) were Utah residents and each
filed, either individually or jointly with a spouse, Utah
individual income tax returns. Additionally, all of the
corporations in which the Taxpayers were shareholders were S
corporations organized in Utah.
¶3 An S corporation is a small business that meets certain
criteria set forth in subchapter S of chapter 1 of subtitle A of
the Internal Revenue Code and thereby qualifies for special
federal tax treatment. 26 U.S.C. § 1361 (2000). A business
becomes an S corporation by shareholder election. Id. § 1362
(2000). Once the election has been made by a qualifying
corporation, it is treated as a pass-through tax entity, meaning
that all revenues, profits, expenses, and losses are passed
through, pro rata, to the shareholders based upon their
percentage of ownership. Id. § 1366 (2000).
¶4 Because of this pass-through characteristic,
shareholders of such corporations are individually responsible
for taxes imposed upon the corporate entity. In this case,
either Texas or California, or both, levied corporate franchise
taxes on the four S corporations at issue.1 The reason these
states did not impose the tax directly on the shareholders rather
than the companies is that states are not obliged to recognize S
corporation status. While both Utah and California recognize S
corporations for state tax purposes, Texas does not. Compare
Utah Code Ann. § 59-7-701 (2004) and Cal. Rev. & Tax. Code
§ 23800 (West 2004) with Tex. Tax Code Ann. § 171.001 (Vernon

2 The California tax is “a tax according to or measured by
a corporation’s net income . . . .” Cal. Rev. & Tax. Code
§ 23151(a) (West 2004). The Texas tax is the greater of 0.25
percent of the corporation’s net taxable capital and 4.5 percent
of the corporation’s net taxable earned surplus. Tex. Tax Code
Ann. § 171.002(b) (Vernon 2002). All of the Taxpayers paid the
Texas tax based on the net taxable earned surplus component of
the tax.
3 The Texas statute states that the tax is a franchise tax
imposed on “each corporation that does business in [Texas].”
Tex. Tax Code Ann. § 171.001 (Vernon 2002 & Supp. 2005).
Likewise the California tax is “for the privilege of exercising
[the] corporate franchises within [California].” Cal. Rev. & Tax
Code § 23151.
4 The MTC Shareholders were also initially denied credits
(continued...)
3 Nos. 20040956, 20030949, 20030887
2002 & Supp. 2005). Also, at all relevant times, California
allowed foreign S corporations doing business in the state to
elect to be treated as regular C corporations for California tax
purposes. Cal. Rev. & Tax Code § 23801(A)(4)(a)(ii) (West 2004).
Because the four corporations were treated as C corporations by
both Texas and California, the taxes were imposed by these states
on the corporation, but the shareholders were ultimately
responsible for their payment.
¶5 The Taxpayers sought to offset the effects of these
taxes by claiming a credit against their Utah individual income
taxes for a portion of the corporate franchise tax which had been
paid by the S corporation to either Texas or California, or both.
The Taxpayers claimed this credit pursuant to Utah Code section
59-10-106. The credits were disallowed. The Taxpayers each
filed Petitions for Redetermination with the Tax Commission to
review the credit denials.
¶6 The Tax Commission conducted four formal hearings to
determine the validity of the credits claimed by the Taxpayers,
one each for the MTC Shareholders, the MacFarlanes, Ms. Baker,
and the Reagans. In each case, the Tax Commission denied the
credits, reasoning that because the Texas and California taxes
were franchise taxes they were not eligible to be credited
against the Taxpayers’ individual income taxes under Utah Code
section 59-10-106. The Tax Commission noted that although the
Texas and California taxes were measured by income,2 they were
imposed on the privilege of doing business within each state.3
Thus, the Tax Commission concluded that such taxes were not “on
income” as required by Utah Code section 59-10-106 in order for a
credit to be claimed.4

4 (...continued)
for taxes paid to Georgia, Louisiana, and the District of
Columbia. However, these credits were subsequently allowed by
the Tax Commission based upon the wording of the respective
statutes and the overall legislative tax scheme of these
governments.
Nos. 20040956, 20030949, 20030887 4
¶7 Taxpayers appealed the decisions of the Tax Commission.
Ms. Baker and the Reagans appealed directly to this court under
Utah Code section 78-2-2(3) (2002). The MTC Shareholders and the
MacFarlanes appealed to the Fourth Judicial District Court, which
granted them summary judgment. The district court found that the
language and purpose of Utah Code section 59-10-106 (2004)
supported a broader interpretation of the statute, particularly
of the phrase “on income.” That court looked not at the label of
the taxes imposed i.e., as a franchise or excise tax as opposed
to an income tax) but instead at the functional effect of the tax
on the taxpayers. The Tax Commission appealed the judgment of
the district court. The parties agreed to consolidate the
appeals of Taxpayers and of the Tax Commission for a
determination of the common legal issue.
¶8 We have jurisdiction over the appeal from the district
court pursuant to Utah Code sections 59-1-608 and 78-2-2(3)(j),
and over the appeals from the Tax Commission pursuant to Utah
Code sections 59-1-602(1) and 78-2-2(3)(e)(ii).
STANDARD OF REVIEW
¶9 A matter “of statutory interpretation [is] a question
of law that we review on appeal for correctness.” State v.
Schofield, 2002 UT 132, ¶ 6, 63 P.3d 667. We also use a
correction of error standard for the conclusions of law of the
Tax Commission, Utah Code Ann. § 59-1-610(b), and review the
conclusions of law of the district court for correctness on
summary judgment. Dick Simon Trucking, Inc. v. Utah State Tax
Comm’n, 2004 UT 11, ¶ 3, 84 P.3d 1197.
ANALYSIS
¶10 The sole issue before this court is whether
shareholders of an S corporation can claim a tax credit under
Utah Code section 59-10-106 (2004) for taxes paid to other states
by the S corporation when those taxes are measured by income.
The Tax Commission argues that shareholders cannot claim such
credits because the term “on income” as used in the statute does
not include taxes labeled as franchise or excise taxes. Such an
interpretation, the Tax Commission believes, is in accordance

5 Nos. 20040956, 20030949, 20030887
with the principle of statutory construction that tax credit
statutes are to be strictly construed against the taxpayer.
¶11 While we recognize the general proposition that tax
credit statutes are to be strictly construed against the
taxpayer, we do not find it conclusive in this case. Instead, we
find that the plain language of section 59-10-106 is clear in
extending credits not only for taxes labeled as income taxes, but
also for franchise or excise taxes measured by income. This
plain language reading is wholly consistent with the statute’s
purpose of avoiding double taxation.
I. THE PLAIN LANGUAGE OF SECTION 59-10-106 IS SUFFICIENTLY
BROAD TO INCLUDE FRANCHISE TAXES MEASURED BY INCOME
¶12 In undertaking statutory construction, “[w]e look first
to the plain language of a statute to determine its meaning.
Only when there is ambiguity do we look further.” J. Pochynok
Co., Inc. v. Smedsrud, 2005 UT 39, ¶ 15, 116 P.3d 353. Moreover,
“[w]hen examining the plain language, we must assume that each
term included in the [statute] was used advisedly.” Carrier v.
Salt Lake County, 2004 UT 98, ¶ 30, 104 P.3d 1208 (citation
omitted).
¶13 Utah Code section 59-10-106 (2004) states:
A resident individual shall be allowed a
credit against the tax otherwise due under
this chapter equal to the amount of the tax
imposed on him for the taxable year by
another state of the United States, the
District of Columbia, or a possession of the
United States, on income derived from sources
therein which is also subject to tax under
this chapter.
The controversy in this case surrounds the definition of the term
“on income.” The Tax Commission argues that there is a
distinction in tax law between excise franchise taxes and taxes
“on income,” even though both types of taxes may be measured by
income. For example, Hellerstein divides taxes measured by
income into two categories: “(1) excise taxes on . . . the
privilege of doing, or the license to do, business in the state;
and (2) taxes on net income derived from or attributable to the
state.” Jerome R. Hellerstein & Walter Hellerstein, State
Taxation, ¶ 7.01 (3d ed. 2000). Because excise and franchise
taxes are distinct from taxes on income, the Tax Commission
asserts that credits are not available for the former under
section 59-10-106.

5 31 U.S.C. § 3124(a) (2000), provides:
Stocks and obligations of the United States
Government are exempt from taxation by a
State or political subdivision of a State.
The exemption applies to each form of
taxation that would require the obligation,
the interest on the obligation, or both, to
be considered in computing a tax, except –
(1) a nondiscriminatory franchise tax or
another nonproperty tax instead of a
franchise tax, imposed on a corporation[.]
In First American National Bank of Knoxville v. Olsen, 751
S.W.2d 417 (Tenn. 1987), the Tennessee Supreme Court held that a
Tennessee excise tax fell under the exception to 31 U.S.C.
Section 3124. The court found that the tax was not an income
tax, which would violate 31 U.S.C. Section 3124, but that it was
a non-property tax because “[t]he excise tax [was] not imposed
directly or indirectly on the obligations themselves or on the
income earned from them but rather on the privilege of utilizing
the corporate form in Tennessee[.]” Id. at 420. The court
concluded that “the distinction between a tax on income and a tax
measured by income . . . survives for any State taxes within the
Federal statutory exceptions [of 31 U.S.C. section 3124].” Id.
at 423 (emphasis in original).
Nos. 20040956, 20030949, 20030887 6
¶14 We do not find this distinction relevant to the case
before us. The Tax Commission has failed to show that this
distinction is recognized in any area apart from state taxation
of income from federal obligations. In that area of the law such
a distinction is sometimes warranted and useful to avoid
rendering state legislation void.5 But there is no reason why
such a distinction should be recognized here. In fact, the
United States Supreme Court rejected just such a distinction in
Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977).
Before Complete Auto, a state could not tax a foreign corporation
for “the ‘privilege’ of doing business as measured by the
apportioned net income,” id. at 285, because the Supreme Court
had held it violated the Commerce Clause. See Spector Motor
Serv., Inc. v. O’Connor, 340 U.S. 602, 603–04 (1951), overruled
by Complete Auto, 430 U.S. 274. At that time, however, states
could impose a tax on the apportioned net income itself. In
effect, the only difference between what was permissible and what
was impermissible was the wording of the imposition statute.
Complete Auto recognized that such a distinction “has no
relationship to economic realities,” and accordingly discarded
it. 430 U.S. at 279. The substance of both types of taxes was
the same, just as the substance of a franchise tax measured by
income is the same as any other tax measured by income.

6 The other case is Brennan v. Director of Revenue, 937
S.W.2d. 210 (Mo. 1997). In Brennan, the Missouri Supreme Court
declined to allow a tax credit for taxes paid to Texas because
the Texas tax had both a capital and an income component. Id. at
211. The court ruled that it was impossible to divide the two
components of the tax. Id. at 212. Even so, the analysis in
Brennan indicates that the Missouri Supreme Court would have
allowed the credit had the tax had a single, income-based
component. Id. at 211. Thus, both cases cited by the Tax
Commission are clearly distinguishable from the present case.
7 Nos. 20040956, 20030949, 20030887
¶15 Rather than being restrictive, as the Tax Commission’s
interpretation suggests, we think that the clear language of
section 59-10-106 is broad and inclusive. Had the Legislature
intended a restrictive meaning it could have used the term of art
“income tax” in place of the term “on income.” Unlike the term
“on income,” a restrictive reading of the term of art “income
tax” is supported by several cases where the term “income tax” is
distinguished from taxes on other subjects, although measured by
income. See J.M. & M.S. Browning Co. v. State Tax Comm’n, 154
P.2d 993, 994 (Utah 1945); Chilivis v. Int’l Bus. Mach. Corp.,
235 S.E.2d 626, 627 (Ga. Ct. App. 1977); Aztar Ind. Gaming Corp.
v. Dep’t. of State Revenue, 806 N.E.2d 381, 385 (Ind. Tax 2004).
¶16 The term “income tax,” however, does not appear in
section 59-10-106. We therefore are persuaded by the Maryland
Court of Appeals, which stated, regarding Maryland’s tax credit
statute:
[This section] does not require, as a
condition for the tax credit, that the other
jurisdiction’s tax be an income tax in any
particular form or be labeled ‘income tax’ or
be exclusively an ‘income tax.’ It simply
requires that there be ‘tax on income paid to
another State . . . .’ Under the plain
language of the [statute], the taxpayers here
have paid a ‘tax on income’ . . . .
Roach v. Controller of the Treasury, 610 A.2d 754, 759 (Md. 1992)
(quoting Md. Code Ann. Tax-Gen. § 10-703(a) (1988)). This
reasoning is equally applicable here.
¶17 The Tax Commission’s focus on the labels of the taxes
as franchise, excise, or income taxes in determining whether or
not these taxes are “on income” is misplaced. Unlike the statute
at issue in Pauley v. Virginia Department of Taxation, 55 Va.
Cir. 215 (Va. Cir. Ct. 2001), one of only two cases6 in which
courts have disallowed tax credits claimed by shareholders in S

7 The Virginia statute in Pauley specifically excluded any
“franchise tax, license tax, excise tax, unincorporated business
tax, occupation tax or any tax characterized as such by the
taxing jurisdiction, although applied to earned or business
income [from credit].” Va. Code Ann. § 58.1-332 (2004).
8 Some courts go even further, looking at the nature of the
tax even when a specific label is used. See Bishop v. District
of Columbia, 401 A.2d 955, 958 (D.C. 1979) (“As to the
characterization of a tax, it is fundamental that the nature and
effect of a tax, not its label, determine if it is an income tax
or not.”).
9 In interpreting “on income” to include franchise and
excise taxes measured by income, we follow the majority of
jurisdictions that have addressed this precise issue. See
Tarrant, 733 A.2d 733; Perez v. Dep’t of Revenue & Taxation,
1998-0330 (La. App. 1 Cir. 3/8/99), 731 So. 2d 406; Baker, 1990
N.Y. Tax LEXIS 715.
Nos. 20040956, 20030949, 20030887 8
corporations, the language of section 59-10-106 does not contain
any restrictive labels, but only defines the group of applicable
taxes with the term “on income.”7 Because such a broad term is
used, labels are not dispositive.8 What is dispositive is the
effect the tax has on the taxpayer. If the tax imposed by the
state in which the corporation is doing business is measured by
income, the taxpayer’s individual income is, in effect, taxed.
This same income is also taxed by Utah. However, the purpose of
tax credit statutes is to avoid this type of double taxation.
See Gray v. Franchise Tax Bd., 286 Cal. Rptr. 453, 455 (Cal. Ct.
App. 1991) (“The purpose of a credit for taxes paid to another
state on income derived in this state is the prevention of double
taxation.”); In Re Baker, 1990 N.Y. Tax LEXIS 715, at *13 (N.Y.
Tax App. 1990) (“[T]he legislative purpose behind the enactment
of the . . . tax credit [is] to avoid double taxation of the same
income.”); Tarrant v. Dep’t of Taxes, 733 A.2d 733, 741 (Vt.
1999) (“The purpose of affording taxpayers credit for income
taxes paid in another state is to prevent or alleviate the burden
of double taxation.”). To adopt the strict, label-based
definition of “on income” offered by the Tax Commission would
frustrate the statutory purpose.9
II. THE RULE OF STRICT CONSTRUCTION OF TAX CREDIT STATUTES
AGAINST THE TAXPAYER IS NOT TO BE APPLIED
IF IT VIOLATES CLEAR LEGISLATIVE INTENT
¶18 The Tax Commission cites “the well-established
principle that tax exemption statutes are to be strictly
construed against the party claiming the exemption” in support of
its narrow definition of the term “on income.” Morton Int’l,

10 Presumably, the reason for the rule of strict statutory
construction is because it serves a guide in determining
legislative intent. Because tax credits and exemptions are
“matters of legislative grace,” Team Specialty Prods., Inc.,
(continued...)
9 Nos. 20040956, 20030949, 20030887
Inc. v. Auditing Div. of the Utah State Tax Comm’n, 814 P.2d 581,
591 (Utah 1991). The Tax Commission urges that this rule be
extended to tax credit statutes as well. Both tax exemptions and
tax credits cause a loss of revenue to the state. It is
reasonable, therefore, for this court to treat them similarly.
Numerous other jurisdictions have done the same. See Canty v.
Idaho State Tax Comm’n, 59 P.3d 983, 987 (Idaho 2002) (“If there
is ambiguity in a tax statute specifically regarding deductions
. . . the law is to be construed strongly against the taxpayer.”
(internal quotation marks omitted)); Manufab, Inc. v. Miss. State
Tax Comm’n, 808 So. 2d 947, 949 (Miss. 2002) (“[T]ax [credits]
will be strictly construed against the taxpayer claiming the
exemption and . . . any dispute will be resolved in favor of the
taxing authority.”); Hermann v. Dir. of Revenue, 47 S.W.3d 362,
365 (Mo. 2001) (“Tax credits and exemptions are construed
strictly and narrowly against the taxpayer.”); Team Specialty
Prods., Inc. v. N.M. Taxation & Revenue Dep’t, 2005-NMCA-020,
¶ 9, 137 N.M. 50, 107 P.3d 4 (N.M. Ct. App. 2004) (“We are guided
by the principle that tax credits are strictly matters of
legislative grace and are to be construed against the taxpayer.”)
(internal quotation marks omitted); Ariz. Dep’t of Revenue v.
Raby, 65 P.3d 458, 460 (Ariz. Ct. App. 2003) (“[T]ax deductions,
subtractions, exemptions, and credits are to be strictly
construed [against the taxpayer].”).
¶19 While we agree that the rule of strict construction
applies to tax exemptions, this rule is only a secondary
consideration that does not always come into play. “[T]he rule
of strict construction should not be utilized to defeat the
intent of the legislative body.” State Dep’t of Assessments and
Taxation v. Belcher, 553 A.2d 691, 695 (Md. 1989). See also
Tarrant v. Dep’t of Taxes, 733 A.2d 733, 739 (“While we recognize
the general rule that statutes granting credits must be strictly
construed against the taxpayer, the construction must not defeat
the purposes of the statute.”). The best evidence of that intent
is the plain language of the statute, Jensen v. Intermountain
Health Care, Inc., 679 P.2d 903, 906 (Utah 1984), and we decide
this case on that basis. Even were we to go beyond the plain
language of section 59-10-106, there is ample evidence that the
Legislature’s intent was to allow the credits at issue. If the
intent of the legislature is manifestly different from the effect
that a strict construction of the statute would produce, the
manifest intent trumps.10

10 (...continued)
2005-NMCA-020, ¶ 9, 107 P.3d 4 (internal quotation marks
omitted), courts may rightly infer that the Legislature would not
want to extend that grace too far, but rather would seek to limit
its application to a select group for a specific reason.
However, as the Vermont Supreme Court stated, “[w]hile we
recognize the general rule that statutes granting credits must be
strictly construed against the taxpayer, the construction must
not defeat the purposes of the statute.” Tarrant, 733 A.2d at
739. See also Belcher, 553 A.2d at 695 (Md. 1989) (“[T]he rule
of strict construction should not be utilized to defeat the
intent of the legislative body.”).
Nos. 20040956, 20030949, 20030887 10
CONCLUSION
¶20 We hold that the term “on income” in Utah Code section
59-10-106 includes taxes measured by or calculated according to
income. It is clear from the use of this broad term that the
Legislature intended to allow taxpayers relief not just from
income taxes, but also from any taxes measured by income that
would lead to double taxation of the same income stream. The
Taxpayers in this case must be allowed a credit for their pro
rata shares of the corporate franchise taxes of both Texas and
California. We therefore affirm the ruling of the district court
granting summary judgment to the Taxpayers and reverse the
decision of the Tax Commission.
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¶21 Associate Chief Justice Wilkins, Justice Durrant,
Justice Parrish, and Justice Nehring concur in Chief Justice
Durham’s opinion.