                                                                     FIFTH DIVISION
                                                                     May 5, 2006




No. 1-03-2142

HONEYWELL INTERNATIONAL, INC., formerly                       )      Appeal from the
known as AlliedSignal, Inc.,                                  )      Circuit Court of
                                                              )      Cook County
                Plaintiff-Appellant,                          )
                                                              )
       v.                                                     )
                                                              )
THE DEPARTMENT OF REVENUE OF THE STATE                        )      Honorable
OF ILLINOIS,                                                  )      Alexander P. White,
                                                              )      Judge Presiding.
                Defendant-Appellee.                           )
                                                              )

       JUSTICE O=MARA FROSSARD delivered the opinion of the court:

       Plaintiff Honeywell International, Inc. (formerly known as AlliedSignal, Inc.), filed a

complaint for administrative review against defendant the Illinois Department of Revenue

(Department) after the Department assessed service occupation tax against it for tax years 1992,

1993, and 1994. Section 3 of the Service Occupation Tax Act (Act) imposes a service

occupation tax on tangible personal property transferred incident to the provision of a service by

one engaged in the business of providing services. 35 ILCS 115/3 West (1994). In the instant

case, the Department imposed service occupation tax on aircraft parts that plaintiff sold to

several customers in conjunction with maintenance it provided on airplanes owned by those

customers. The trial court affirmed the Department=s imposition of service occupation tax

(SOT). Plaintiff now appeals, contending that it was exempt from paying the SOT because it

delivered, and its customers received, physical possession of the aircraft and the installed parts
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outside Illinois.

                                          BACKGROUND

        The following facts are not in dispute. During the tax years in question plaintiff was a

diversified technology, manufacturing, and service company that served customers worldwide

with aerospace products and services, automotive products, chemicals, fibers, and plastics.

Plaintiff operated approximately 400 facilities and employed approximately 86,000 workers

within the United States and 40 other countries. As part of its aerospace business, plaintiff

provided and sold tangible personal property to owners of business aircraft during the tax years

in question. Among the services provided by plaintiff were retrofits of business aircraft. A

retrofit involved the removal of the original engines on the aircraft, the sale and installation of

new engines, and the sale and installation of new pylons, nacelles, and associated wiring,

plumbing, and cockpit instrumentation necessary to accommodate the new engines. A retrofit

could also include the sale and installation of upgraded avionics, auxiliary power units, thrust

reversers, and refurbishments to the interior of the aircraft.

        During the audit period, plaintiff retrofitted 11 privately owned business aircraft and

provided other services to 2 other business aircraft at a hangar it operated in Springfield, Illinois.

The owners of these 13 aircraft resided outside Illinois, and each of the aircraft was hangared

outside Illinois. In each of the 13 transactions, a written contract was entered into between

plaintiff and the customer, specifying the retrofit and other modification work to be done. The

aircraft was flown by the customer to the Springfield hangar, and the agreed-upon retrofit or

other modification was performed. Eleven of the thirteen contracts provided that when plaintiff



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completed the servicing of the aircraft in question, the customer was required to inspect and

accept the installation of the parts before the airplane left Illinois.

        After completion of the inspections and servicing, the aircraft were flown by plaintiff=s

personnel to several different delivery locations outside Illinois pursuant to agreements between

plaintiff and its customers. Seven of the aircraft were flown to Delaware, two were flown to

Indiana, two were flown to Colorado, one was flown to Massachusetts, and one was flown to

Oregon. Only plaintiff=s personnel were on the aircraft when they were flown to the out-of-state

locations and delivered to their owners. When each of the 13 aircraft was delivered, the owner

signed, at the delivery location, a final acceptance and delivery statement.

        During the audit period, plaintiff filed monthly Illinois occupation and use tax returns, on

which it reported its occupation and use tax liabilities, including the service occupation tax.

Plaintiff did not report its sales of aircraft parts pursuant to the 13 contracts as subject to the

service occupation tax.

        Plaintiff charged and collected Indiana sales tax from two customers (in the amounts of

$105,000 and $113,250, respectively) on the parts installed in the two aircraft delivered in

Indiana, and Massachusetts sales tax from one customer (in the amount of $107,500) on the parts

installed in the aircraft delivered in Massachusetts. Plaintiff did not charge or collect sales tax

from the owners of the aircraft delivered in Delaware or Oregon because those states do not have

a retail sales tax. Plaintiff did not charge or collect sales tax from the owners of aircraft

delivered in Colorado because the parts installed in those aircraft were exempt from sales tax

under Colorado law.



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1-03-2142

       The Department conducted an audit of plaintiff=s aircraft service operations at the

Springfield hangar and issued three ANotices of Tax Liability@ to plaintiff for Illinois service

occupation tax, penalties, and interest in the aggregate amount of $3,664,375. The notices were

based on the Department=s contention that the aircraft parts sold by plaintiff and installed into the

13 aircraft were subject to the Illinois service occupation tax. Plaintiff filed three timely protests

and requests for hearing.

       On January 16, 2002, following an administrative hearing, the administrative law judge

(ALJ) issued a written recommendation that plaintiff pay tax on the cost of all tangible personal

property sold pursuant to the 13 contracts with out-of-state businesses. The ALJ found in

relevant part:

                 AAfter considering the documentary evidence in this record, as well as the

       pertinent legal decisions, I conclude that [plaintiff] delivered physical possession

       of the goods it transferred to customers incident to its sales of service when it

       completed its installation of the goods into or onto each aircraft, so that they

       became fully-functioning component parts of the customer=s aircraft. ***

       Because of the very nature of its business, taxpayer delivered the goods to its

       customer in Illinois by physically installing them into or onto the customer=s

       aircraft, at its Illinois hangar. As a practical matter, this means that [plaintiff]

       delivered physical possession of the goods to the customer when it satisfied its

       contractual, and federally required, obligation to have all of its installation work

       certified as being properly completed, and its customer=s aircraft certified as being



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1-03-2142

       airworthy, by a FAA inspector. ***

               In the event [plaintiff] does not deliver physical possession of the new

       engines and other goods it installs into or onto its customer=s aircraft at the time it

       makes them fully functioning component parts thereof, however, the SOT still

       applies to the transactions at issue. At the latest, [plaintiff] delivers physical

       possession of the goods it transfers incident to its sales of service when its

       customers come into Illinois and accept the goods and related services [plaintiff]

       has provided. That acceptance occurs while an aircraft is in Illinois, and after the

       customer has come into Illinois to conduct the final inspection called for by the

       agreement between them. It is only after such acceptance that [plaintiff] will

       agree to redeliver possession of the owner=s bailed plane by flying it to the owner

       outside Illinois.

               A customer/bailor=s subsequent decision to have [plaintiff] start, takeoff

       and fly an aircraft from its Illinois hangar to a point outside Illinois to deliver it -

       as opposed to the installed goods the customer has already accepted in Illinois -

       back to the customer is, as [plaintiff=s] contracts show, a discrete service that is

       ancillary to the primary subject matter of its agreement with each customer.@

In addition to making the above findings, the ALJ concluded that plaintiff was entitled to a credit

for the aggregate amount of tax due and paid to the states of Massachusetts and Indiana.

       On February 8, 2002, the Director of the Department accepted the ALJ=s

recommendation, and in April 2002, plaintiff filed a complaint for administrative review of the



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Director=s decision in the circuit court of Cook County. On June 25, 2003, the circuit court

issued its decision affirming the Director=s imposition of service occupation tax and late

penalties against plaintiff. In its memorandum decision and judgment, the court rejected

plaintiff=s argument that physical delivery of the airplane parts did not occur in Illinois. Plaintiff

now appeals that decision.

                                            ANALYSIS

       We are required to review the Department=s decision rather than the circuit court=s

decision. Calabrese v. Chicago Park District, 294 Ill. App. 3d 1055, 1065 (1998). AAn

administrative agency=s decisions on questions of fact are entitled to deference and are reversed

only if against the manifest weight of the evidence.@ Friends of Israel Defense Forces v.

Department of Revenue, 315 Ill. App. 3d 298, 302 (2000). AWe do not give deference to an

agency=s decisions on questions of law, and we review such decisions de novo.@ Arts Club of

Chicago v. Department of Revenue, 334 Ill. App. 3d 235, 241-42 (2002).

       A mixed question of law and fact Ainvolves examination of the legal effect of a given set

of facts@ and is subject to the clearly erroneous standard of review. City of Belvidere v. Illinois

State Labor Relations Board, 181 Ill. 2d 191, 205 (1998). AThe clearly erroneous standard of

review is between a manifest weight of the evidence standard and a de novo standard so as to

provide some deference to the administrative agency=s experience and expertise.@ Friends of

Israel Defense Forces, 315 Ill. App. 3d at 303. The clearly erroneous standard requires us to

accept the findings of the administrative agency Aunless we are firmly convinced the agency has

made a mistake.@ Randolph Street Gallery v. Zehnder, 315 Ill. App. 3d 1060, 1064 (2000).



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1-03-2142

        The issue in the instant case is whether the Department properly found plaintiff was not

exempt from service occupation tax. The facts related to this issue are not in dispute. Rather,

the parties dispute whether those facts satisfy the requirements of the interstate commerce

exemption included in the Act. Accordingly, we apply the clearly erroneous standard of review.

        Section 3 of the Service Occupation Tax Act (Act) provides for the imposition of service

occupation tax and states in relevant part:

                       AA tax is imposed upon all persons engaged in the business

               of making sales of service (referred to as >servicemen=) on all

               tangible personal property transferred as an incident of a sale of

               service ***.@ 35 ILCS 115/3 (West 1994).

        Plaintiff claims that section 3-45 of the Act and section 140.501(b) of the Illinois

Administrative Code (Code), which contains the corresponding regulation promulgated by the

Department, exempt it from paying the SOT imposed by the Department under section 3 of the

Act. 35 ILCS 115/3-45 (West 1994); 86 Ill. Adm. Code ' 140.501 (1994). We note that Aa party

claiming an exemption has the burden to prove clearly and conclusively that he is entitled to the

exemption@ (Telco Leasing, Inc. v. Allphin, 63 Ill. 2d 305, 310 (1976)), and that A[s]tatutory

exemptions to taxation *** are to be strictly construed in favor of taxation@ (XL Disposal Corp.

v. Zehnder, 304 Ill. App. 3d 202, 207 (1999)).

        Section 3-45 of the Act, known as the interstate commerce exemption, states in relevant

part:




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1-03-2142

                       ANo tax is imposed under this Act upon the privilege of

               engaging in a business in interstate commerce or otherwise when

               the business may not, under the Constitution and statutes of the

               United States, be made the subject of taxation by this State.@ 35

               ILCS 115/3-45 (West 1994).

       Section 140.501 of the Code, which the Department promulgated to assist taxpayers in

determining when the interstate commerce exemption is applicable, states in relevant part:

               A(a) Where tangible personal property is located in this State at the time of

       its transfer (or is subsequently produced in Illinois) as an incident to a sale of

       service, and is then delivered in Illinois, the serviceman incurs Service

       Occupation Tax liability on the selling price of the property. The sale is not

       deemed to be in interstate commerce if the purchaser or his representative

       receives the physical possession of such property in this State. ***

               (b) The serviceman does not incur Service Occupation Tax liability on

       property which he resells as an incident to a sale of service under an agreement by

       which the serviceman is obligated to make physical delivery of the goods from a

       point in this State to a point outside this State, not to be returned to a point within

       this State, provided that such delivery is actually made.@ (Emphasis added.) 86

       Ill. Adm. Code ' 140.501 (1994).

       The parties do not dispute that the above provisions of the Code exempt a taxpayer from

paying service occupation tax if he delivers physical possession of the subject tangible personal



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property outside of Illinois. Rather, they dispute the meaning of physical possession and

whether the undisputed facts in the instant case established that plaintiff delivered physical

possession of the parts incorporated into the airplane inside or outside of Illinois.

        The Department contends that A[t]he Director did not clearly err in denying the interstate

commerce exemption because [plaintiff] physically transferred the property to the customer in

Illinois when it was installed into the aircraft and accepted by the customer.@ The Department

contends that A[t]he facts establish that [plaintiff] did deliver physical possession of the aircraft

parts in Illinois, both physically installing them into and onto the customer=s property in Illinois

and by requiring the customer to come into Illinois to accept those parts as conforming to the

service contract.@

        Plaintiff contends that A[n]either the installation of the parts nor approval of the

installation constitute[s] the delivery and receipt of physical possession of the parts in Illinois.@

Plaintiff reasons that Athese facts [the installation of the parts and the approval of the installation]

related only to the location at which [plaintiff=s] services were provided, not where [plaintiff]

delivered physical possession of the parts to the customers.@ We agree.

        Neither the Act nor the Code defines Aphysical@ or Apossession,@ and accordingly, we

look to their plain and ordinary meaning.

        Black=s Law Dictionary defines Aphysical@ as:

                        ARelating or pertaining to the body, as distinguished from

                the mind or soul or the emotions. Material, substantive, having an

                objective existence, as distinguished from imaginary or fictitious;



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1-03-2142

               real, having relation to facts, as distinguished from moral or

               constructive.@ Black=s Law Dictionary 1032 (5th ed. 1979).

       Black=s Law Dictionary defines Apossession@ as:

                      AThe detention and control, or the manual or ideal custody,

               of anything which may be the subject of property, for one=s use and

               enjoyment, either as owner or as the proprietor of a qualified right

               in it, and either held personally or by another who exercises it in

               one=s place and name. Act or state of possessing. That condition

               of facts under which one can exercise his power over a corporeal

               thing at his pleasure to the exclusion of all other persons.

                      The law, in general, recognizes two kinds of possession:

               actual possession and constructive possession. A person who

               knowingly has direct physical control over a thing, at a given time,

               is then in actual possession of it. A person who, although not in

               actual possession, knowingly has both the power and the intention

               at a given time to exercise dominion or control over a thing, either

               directly or though another person or persons, is then in

               constructive possession of it.@ (Emphasis added.) Black=s Law

               Dictionary 1047 (5th ed. 1979).

       The above definitions unambiguously reflect that one does not have physical possession

of tangible personal property unless he has the ability, at a given time, to exercise dominion and



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control over that property. Plaintiff=s installation of the parts into the aircraft did not magically

render its customers able to control those parts. While the subject contracts called for plaintiff=s

customers to inspect and accept the completed work in Illinois, the contracts did not reflect that

such inspections would require customers to exercise dominion and control over the property.

Indeed, once the inspections were concluded, the customers left Illinois without their aircraft or

the parts installed on the aircraft.

        The requirement that property be physically delivered in Illinois derives from limitations

imposed on states= taxing authority by the commerce clause of the United States Constitution.

See U.S. Const., art. I, ' 8 (A[t]he Congress shall have Power *** [t]o regulate Commerce ***

among the several States@). The United States Supreme Court has observed that this requirement

insures that only one state can tax the sale of tangible personal property. See Oklahoma Tax

Comm=n v. Jefferson Lines, Inc., 514 U.S. 175, 131 L. Ed. 2d 261, 115 S. Ct. 1331 (1995). In

Jefferson Lines, the Supreme Court explained:

                AA sale of goods is most readily viewed as a discrete event

                facilitated by the laws and amenities of the place of sale, and the

                transaction itself does not readily reveal the extent to which

                completed or anticipated interstate activity affects the value on

                which a buyer is taxed. We have therefore consistently approved

                taxation of sales without any division of the tax base among

                different States, and have instead held such taxes properly

                measurable by the gross charge for the purchase, regardless of any



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                activity outside the taxing jurisdiction that might have preceded

                the sale or might occur in the future. See e.g., McGoldrick v.

                Berwind-White Coal Mining Co., supra.

                        Such has been the rule even when the parties to a sales

                contract specifically contemplated interstate movement of the

                goods either immediately before, or after, the transfer of

                ownership. *** The sale, we held, was >an activity which $$$ is

                subject to the state taxing power= so long as taxation did not

                >discriminat[e]= against or >obstruc[t]= interstate commerce,

                [citation.], and we found a sufficient safeguard against the risk of

                impermissible multiple taxation of a sale in the fact that it was

                consummated in only one State. As we put it in Berwind-White, a

                necessary condition for imposing the tax was the occurrence of 'a

                local activity, delivery of the goods within the State upon their

                purchase for consumption.' [Citation.] So conceived, a sales tax

                on coal, for example, could not be repeated by other States, for the

                same coal was not imagined ever to be delivered in two States at

                once.@ (Emphasis added.) Jefferson Lines, 514 U.S. at 186-87, 131

                L. Ed. 2d at 272-73, 115 S. Ct. at 1339.

        In the instant case, plaintiff flew the airplanes, which included the parts sold incident to

servicing, not to locations inside of Illinois but to locations outside of Illinois. Plaintiff did not



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relinquish, and its customers did not acquire, physical control of those airplanes until they were

no longer in Illinois. Plaintiff charged and collected Indiana and Massachusetts retail sales tax

from customers who received physical delivery of their airplanes in Indiana and Massachusetts

as those states had a retail sales tax and did not exempt the subject transactions from sales tax.

Accordingly, we conclude that the Department=s decision to impose service occupation tax on

the parts transferred by plaintiff pursuant to its servicing of the airplanes in question was clearly

erroneous.

        In support of its argument that denying a tax exemption in the instant case was proper,

the Department cites three cases involving sales which were found not to be in interstate

commerce: American Airlines, Inc. v. Department of Revenue, 58 Ill. 2d 251, 259 (1974),

Pressed Steel Car Co. v. Lyons, 7 Ill. 2d 95, 104 (1955), and Superior Coal Co. v. Department of

Finance, 377 Ill. 282, 296-97 (1941). The Department=s reliance on these cases, however, is

misplaced as in each case the purchaser took physical possession of the property in Illinois

before leaving Illinois. See American Airlines, 58 Ill. 2d at 252, 259-60 (meals sold by retailer

were loaded onto American Airlines airplanes in Illinois before airplanes were flown out of

Illinois); Pressed Steel, 7 Ill. 2d at 97, 99 (railroad equipment sold by manufacturer to railroads

was physically received in Illinois by railroads before those railroads transported it out of state);

Superior Coal, 377 Ill. 2d at 296 (railway company purchasing coal Aobtains complete possession

of the coal in its cars in Illinois at the mines,@ and it is irrelevant that coal was intended for use

outside of Illinois).

        In addition to contending that plaintiff was not exempt from paying service occupation



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1-03-2142

tax, the Department contends that late payment penalties were properly assessed against plaintiff.

Because the transactions in this case are not subject to service occupation tax, we find that the

related penalties were improperly imposed.

                                         CONCLUSION

       Based on the foregoing reasons, we conclude that the Department=s decision to assess

service occupation tax and related penalties was clearly erroneous. Accordingly, we reverse the

decision of the Department and we reverse the circuit court=s decision affirming the decision of

the Department.

       Reversed.

       GALLAGHER, P.J., and NEVILLE, J., concur.




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