ATTORNEYS FOR PETITIONER:                      ATTORNEYS FOR RESPONDENT:
FRANCINA A. DLOUHY                             CURTIS T. HILL, JR.
DANIEL R. ROY                                  ATTORNEY GENERAL OF INDIANA
FAEGRE BAKER DANIELS LLP                       WINSTON LIN
Indianapolis, IN                               DEPUTY ATTORNEY GENERAL
                                               Indianapolis, IN
HOLLIS L. HYANS
MORRISON & FOERSTER LLP
New York, New York



                               IN THE
                         INDIANA TAX COURT

E.I. DUPONT DE NEMOURS and                   )
COMPANY,                                     )
                                             )
      Petitioner,                            )
                                             )
                    v.                       ) Cause No. 49T10-1307-TA-00065
                                             )                                        FILED
INDIANA DEPARTMENT OF                        )                                    Jul 11 2017, 4:22 pm
STATE REVENUE,                               )
                                                                                      CLERK
                                             )                                    Indiana Supreme Court
                                                                                     Court of Appeals
      Respondent.                            )                                         and Tax Court




        ORDER ON PARTIES’ CROSS-MOTIONS FOR SUMMARY JUDGMENT

                                 FOR PUBLICATION
                                   July 11, 2017

WENTWORTH, J.

      E.I. DuPont De Nemours and Company (“DuPont”) has appealed the Indiana

Department of State Revenue’s final determination assessing it with additional adjusted

gross income tax (AGIT) and interest for the 2006 and 2007 tax years and a penalty for

2007. DuPont’s appeal is currently before the Court on the parties’ cross-motions for
summary judgment. In resolving those cross-motions, the Court grants each in part and

denies each in part.

                           FACTS AND PROCEDURAL HISTORY

       DuPont, a Delaware corporation, was founded in 1802. (App. Pet’r Mot. Summ. J.

(“Pet’r Des’g Evid.”), Vol. III, Aff. of Gary M. Pfeiffer (“Pfeiffer Aff.”) ¶ 3). Originally, DuPont

manufactured gunpowder. (See Pet’r Br. Supp. Mot. Summ. J. (“Pet’r Br.”) at 30-31.) See

also Wikipedia, https://en.www.wikipedia.org/wiki/DuPont (last visited July 10, 2017).

Today, however, it is engaged with its subsidiaries and affiliates in a variety of industrial,

agricultural, and chemical manufacturing businesses worldwide. (Pfeiffer Aff. ¶ 3.)

                          A. DuPont’s Pharmaceutical Business

       In 1991, DuPont and Merck & Co., Inc. formed the DuPont Merck Pharmaceutical

Company (“DMPC”). (Pfeiffer Aff. ¶¶ 6-7.) DuPont and Merck each owned equal 50%

interests in DMPC, which researched, developed, manufactured, and sold human

pharmaceutical products, imaging agent products, and other related product lines.

(Pfeiffer Aff. ¶¶ 6, 9; Pet’r Des’g Evid., Vol. I, Ex. 1 at DIN 1161.)           DMPC operated

independently of DuPont and Merck: it maintained its own management team, its own

separate research agenda and development facilities, its own employees, its own profit

objectives, and its own separate operating policies and procedures. (Pfeiffer Aff. ¶¶ 9-12;

Pet’r Des’g Evid., Vol. III, Aff. of Kurt M. Landgraf (“Landgraf Aff.”) ¶¶ 17-18.) While

DuPont initially leased certain facilities to DMPC and provided it with some “start-up”

personnel and administrative services, DuPont charged DMPC arm’s-length fees for the

services it rendered. (See Resp’t Des’g Evid., Ex. 2G at DIN 1555-62, 1577-78.)

                                                 2
       In 1998, Merck sold its 50% interest in DMPC to DuPont Pharma, Inc., a subsidiary

of DuPont. (See, e.g., Pfeiffer Aff. ¶¶ 13-14, 17; Resp’t Des’g Evid., Ex. 2H.) At that point,

DMPC was renamed DuPont Phamaceuticals Company (“DPC”).                   (Pfeiffer Aff. ¶ 17.)

While DPC received certain start-up services from DuPont, for which it paid arm’s-length

fees, it otherwise operated independently of DuPont. (Landgraf Aff. ¶ 29; Resp’t Des’g

Evid., Ex. 5 at 56.)

       In 2001, DuPont sold DPC to Bristol-Meyers Squibb Company. (Pfeiffer Aff. ¶¶ 37,

41; Pet’r Des’g Evid., Vol. II, Ex. 9.) The sale generated a gain of over $4 billion to

DuPont. (Resp’t Des’g Evid., Ex. 6 at 4.)

                           B. DuPont’s Financing Arrangements

       In 1995, DuPont Energy Company (“DEC”), a subsidiary of Dupont through

Dupont’s ownership of Conoco, Inc. and its subsidiaries, loaned DuPont nearly $8 billion at

an interest rate of 8.528% (“1995 Loan”). (Pet’r Des’g Evid., Vol. III, Aff. of Sharon E. Smith

(“Smith Aff.”) ¶ 3, Ex. 10, Aff. of Noah Schreiber (“Schreiber Aff.”) ¶ 3, Aff. of Sherif Assef

(“Assef Aff.”) ¶ 4a; Resp’t Des’g Evid., Ex. 2J.) The 1995 Loan terms did not require

DuPont to make any payments on either the interest or the principal until 2005. (Resp’t

Des’g Evid., Ex. 2J.)

       In 1998, DEC assigned the promissory note associated with the 1995 Loan to

another DuPont subsidiary, DuPont Global Operations, Inc. (“DGOI”). (Smith Aff. ¶ 3; Pet’r

Des’g Evid., Vol. III, Ex. 10.) In 1999, DGOI loaned DuPont $3.9 billion at an interest rate

of 7.40% (“1999 Loan”). (Smith Aff. ¶ 4; Pet’r Des’g Evid., Vol. III, Ex. 11.) The 1999 Loan

                                              3
terms did not require DuPont to make any payments on either the interest or the principal

until 2009. (Pet’r Des’g Evid., Vol. III, Ex. 11.)

         On August 31, 2005, the 1995 Loan came due. (Resp’t Des’g Evid., Ex. 2J at DIN

2027.)     That same day, DGOI loaned DuPont $12.2 billion (“2005 Loan”) – which equaled

the full value of the principal and the total interest due on the 1995 Loan – at an interest

rate of 5.64%.     (See Resp’t Des’g Evid., Exs. 2L at DIN 2065, 4 at 7-8 (Petitioner’s

Response to Respondent’s First Request for Admissions at No. 8 (indicating that because

DuPont never made any payments on the 1995 Loan, the principal and accrued interest on

the 1995 Loan were rolled over and became the principal balance on the 2005 Loan)).)

Similar to the 1995 Loan, the 2005 Loan terms did not require DuPont to make any

payments on the principal or the interest for ten years. (See Resp’t Des’g Evid., Ex. 2L at

DIN 2065.)

                                         C. Indiana Audit

         For tax years 1997 through 2007, DuPont and its subsidiaries filed consolidated

Indiana AGIT returns. (See Pet’r Des’g Evid., Vol. III, Ex. 16; Resp’t Des’g Evid., Confd’l

Ex. 2O.) In 2009, the Department audited the consolidated 2005, 2006, and 2007 returns.

(See Resp’t Des’g Evid., Ex. 3 ¶¶ 5-6.)              As a result of the audit, the Department

determined that DuPont had improperly reported 1) net operating losses (“NOLs”) by

characterizing the gain from the 2001 sale of DPC as nonbusiness income; 2) interest

expense deductions on the loans it received from DEC and DGOI; and 3) a research and

development (“R&D”) expense deduction.               (See Resp’t Des’g Evid., Ex. 3 ¶¶ 8-20.)



                                                4
Accordingly, the Department made the following adjustments to DuPont’s consolidated

returns:

           1) it reclassified the gain DuPont received from the sale of DPC as
              apportionable business income, increasing DuPont’s 2001 adjusted
              gross income by nearly $5 billion and reducing the amount of NOLs
              DuPont could carry forward to subsequent years;

           2) it eliminated the interest expense deductions DuPont reported
              between 2005 and 2007 that were related to the 1995, 1999, and
              2005 Loans, increasing DuPont’s adjusted gross income in 2006
              and 2007 by approximately $3 billion and further reducing DuPont’s
              available NOLs carry forward;

           3) it eliminated DuPont’s 2007 R&D expense deduction, increasing
              DuPont’s 2007 adjusted gross income by another $43 million.

(See Resp’t Des’g Evid., Ex. 3 ¶¶ 9-20, Confd’l Ex. 8 at 4.)

       The Department’s three adjustments culminated in the issuance of Proposed

Assessments against DuPont for an additional $394,490 in AGIT liability plus interest for

2006 and $376,328 plus interest for 2007. (Resp’t Des’g Evid., Ex. 3 ¶¶ 21-22; Ex. 7.)

The Department also assessed a $37,627 penalty against DuPont for tax year 2007.

(Resp’t Des’g Evid., Ex. 7 at 6.)         DuPont subsequently protested the Proposed

Assessments but, after conducting a hearing, the Department denied the protest in a Letter

of Findings. (Resp’t Des’g Evid., Confd’l Ex. 8.)

       On July 26, 2013, DuPont filed an original tax appeal, claiming the Department’s

audit adjustments were improper. DuPont and the Department filed cross-motions for

summary judgment, and the Court conducted a hearing on the motions on March 4, 2016.

                                 STANDARD OF REVIEW

       Summary judgment is appropriate when there are no genuine issues of material fact

and the moving party is entitled to a judgment as a matter of law. Ind. Trial Rule 56(C).


                                              5
Cross-motions for summary judgment do not alter this standard. Horseshoe Hammond,

LLC v. Indiana Dep’t of State Revenue, 865 N.E.2d 725, 727 (Ind. Tax Ct. 2007), review

denied.

                                          ISSUES

       The parties’ cross-motions for summary judgment present the following questions

for the Court’s resolution:

          I. Did the Department have the authority to make adjustments to
          DuPont’s NOLs in years that were closed to assessment under the
          applicable statute of limitations?

          II. Did the Department err when it reclassified DuPont’s gain on its
          2001 sale of DPC from nonbusiness income to business income?

          III. Did the Department err when it disallowed the interest expense
          deductions DuPont reported on its 2006 and 2007 returns on the basis
          that the underlying loans were sham transactions?

          IV. Did the Department err when it disallowed DuPont’s 2007 R&D
          expense deduction?

          V. Did the Department err when it imposed a penalty for 2007?

(Compare Pet’r Br. at 14, 20, 33, 41, 44 with Resp’t Br. Opp’n Pet’r Mot. Summ. J. & Supp.

Resp’t Cross-Mot. Summ. J. (“Resp’t Br.”) at 2.)

                                   ANALYSIS AND ORDER

                              I.   Retroactive Adustments

       The Department’s Proposed Assessments against DuPont were partly the result of

reductions it made to the NOLs DuPont reported on its pre-2005 tax returns that resulted in

lower NOL carry forwards that DuPont could deduct on its 2006 and 2007 returns. See

supra, pp. 4-5.    DuPont gives two primary reasons why the Department’s retroactive

adjustments are improper. First, it claims that Indiana Code § 6-8.1-5-2 prohibited the

                                             6
Department from making adjustments to the pre-2005 tax years because those tax years

were “closed,” i.e., outside the statute of limitations. (See, e.g., Pet’r Br. at 1-2, 14-15, 18.)

Second, DuPont asserts that strong policy reasons auger against allowing the Department

to make the adjustments it did. (See Pet’r Br. at 15 (claiming that adjustments like the

ones at issue disrupt settled expectations, create uncertainty for taxpayers, and increase

the costs of preserving evidence).) The Court is not persuaded by DuPont’s reasoning,

however, for the following four reasons.

       First, the Department’s audit reviewed DuPont’s 2005 through 2007 returns for

accuracy. See, e.g., IND. CODE §§ 6-8.1-1-1, -2-1 (2009) (providing that the Department is

charged with the administration, collection, and enforcement of the AGIT); IND. CODE §§ 6-

8.1-3-1, -3-12(a) (2009) (explaining that to accomplish its charge, the Department has

broad powers that include audit and investigatory powers). Accordingly, the accuracy of

the NOL deductions DuPont reported in 2005, 2006, and 2007 was contingent upon the

accuracy of its initial NOL calculation in 2001, the year the NOL was actually incurred and

therefore could be carried forward for a period of up to 20 years. See, e.g., IND. CODE § 6-

3-2-2.6 (2006) (amended 2010); I.R.C. § 172(b) (2006); Subaru-Isuzu Automotive, Inc. v.

Indiana Dep’t of State Revenue, 782 N.E.2d 1071, 1076-77 (Ind. Tax Ct. 2003). As a

result, it was incumbent upon the Department to examine and perhaps even recalculate

the NOL DuPont reported in 2001. See, e.g., Hillenga v. Dep’t of Revenue, 361 P.3d 598,

603, 606 (Or. 2015) (concluding that “[a] taxpayer who seeks to apply a carryover from a

closed year against the income from an open one actively puts the carryover from the

closed year in issue”).




                                                7
       Second, Indiana Code § 6-8.1-5-2(a) prohibits the Department from issuing a

proposed assessment to a taxpayer more than 3 years after the date its return is filed or

due, whichever is later. IND. CODE § 6-8.1-5-2(a)(1) (2006) (amended 2009). The statute

is silent regarding whether adjustments may be made to tax returns outside that time

frame. See I.C. § 6-8.1-5-2(a)(1). Because Indiana Code § 6-8.1-5-2(a) sets time limits on

assessments only, its plain language does not support DuPont’s claim that the Department

was prohibited from adjusting the NOLs DuPont reported prior to 2005. See, e.g., SAC

Fin., Inc. v. Indiana Dep’t of State Revenue, 24 N.E.3d 541, 547 (Ind. Tax Ct. 2014)

(explaining that because the Legislature intentionally chooses its language, the Court will

not expand or contract the meaning of a statute by reading language into it that is not

there), review denied; Scopelite v. Indiana Dep't of Local Gov’t Fin., 939 N.E.2d 1138,

1143 (Ind. Tax Ct. 2010) (explaining that it is equally as important to recognize what

statutes do not say as it is to recognize what they do say).

       Third, DuPont has not directed the Court to any authority that precludes the

Department from making adjustments to “closed” years. (See Pet’r Br. at 14-20.) In fact,

DuPont admits that it is not aware of any statutory provision or case law that prohibits the

type of adjustments the Department made in this case. (See Hr’g Tr. at 49-50.)

       Finally, the policy against retroactive taxes that promotes certainty and preserves

settled expectations is not implicated here. Even though the Department may correct an

error in a “closed” year, it cannot assess additional tax beyond the express statutory time

limit. See I.C. § 6-8.1-5-2(a). Thus, DuPont has received the “closure and certainty” to

which it is entitled. Indeed, while

          [a] taxpayer cannot . . . claim [a] carryover while precluding any review
          of its merit . . . claiming a net loss carryover from a closed tax year does
                                               8
          not open that tax year for purposes of assessing a deficiency. . . .[T]he
          calculation of the carryover credit from the closed year [may be
          revisited] only for the purpose of determining the tax liability for the
          open year.

Hillenga, 361 P.3d at 606. Moreover, the lament that it may be costly to preserve records

and documentation to substantiate an NOL for a period of up to 20 years is unavailing

because DuPont placed itself in this position intentionally when it chose to deduct the 2001

NOL in the first place.       Therefore, DuPont has not persuaded the Court that the

Department’s retroactive NOL adjustments – without accompanying assessments – were

improper.1

                              II. Apportionable Business Income

       DuPont contends that even if the Department had the authority to adjust its NOL

deductions in closed years, it improperly reclassified DuPont’s gain from the 2001 sale of

DPC from nonbusiness income to business income. Indiana Code § 6-3-1-20 defines

“business income” as “income arising from transactions and activity in the regular course

of the taxpayer’s trade or business and includes income from tangible and intangible

property if the acquisition, management, and disposition of the property constitutes integral




1
 DuPont has also argued that the Department’s retroactive adjustments violate its equal protection
and due process rights. (See Pet’r Br. Supp. Mot. Summ. J. (“Pet’r Br.”) at 19-20.) DuPont has
done very little to develop this argument other than assert that the adjustments result in the
disparate treatment between taxpayers that claim NOLs and taxpayers that do not. (See Pet’r Br.
at 19-20). Accordingly, the Court will not address DuPont’s argument. See U.S. Fid. & Guar. Ins.
Co. v. Hartson-Kentucky Cabinet Top Co., 857 N.E.2d 1033, 1038 (Ind. Ct. App. 2006) (stating that
where a party presented no cogent argument to support its assertion, the assertion was waived).


                                                9
parts of the taxpayer’s regular trade or business operations.”2         IND. CODE § 6-3-1-20

(2001). “Nonbusiness income” is defined as “all income other than business income.” IND.

CODE § 6-3-1-21 (2001). The distinction between business and nonbusiness income is

important when calculating a company’s Indiana AGIT liability because business income is

apportioned between Indiana and the other states in which the company does business,

but nonbusiness income is allocated to just one state.         See May Dep’t Stores Co. v.

Indiana Dep’t of State Revenue, 749 N.E.2d 651, 656 (Ind. Tax Ct. 2001) (citing IND. CODE

§ 6-3-2-2).

       To determine whether a taxpayer’s income is business income, the Court applies

two tests. See id. at 662-63. The first is the transactional test, which arises from the first

part of Indiana’s statutory definition of business income, i.e., that business income “‘means

income arising from transactions and activity in the regular course of a taxpayer’s trade or

business[.]’” Id. at 658 (quoting I.C. § 6-3-1-20). Under this test, “the ‘controlling factor by

which business income is identified is the nature of the particular transaction giving rise to

the income.’” Id. (citation omitted). Accordingly, the Court may consider, among other

things: “(1) the frequency and regularity of similar transactions; (2) the former practices of

the business; and (3) the taxpayer’s subsequent use of the income.” Id. at 659 (citations

omitted).

       DuPont’s gain is business income under the transactional test if the sale of DPC

occurred in the regular course of DuPont’s trade or business. See May, 749 N.E.2d at
2
   Indiana has not adopted the Uniform Division of Income for Tax Purposes Act (UDITPA), but it
uses the identical language to define business income that is found in UDITPA. Compare IND.
CODE § 6-3-1-20 (2001) with Jerome R. Hellerstein & Walter Hellerstein, State Taxation, Table 9-1
(listing states that have adopted UDITPA), ¶ 9.05[1] (3d ed. 1998 & Supp. 2015). (See also Pet’r
Br. at 29 n.5.)


                                               10
659. The Department asserts that DuPont’s gain was received in the regular course of its

trade or business of buying and selling companies. (Resp’t Br. at 16.) As evidence, the

Department refers to DuPont’s IRS Form 851 Affiliation Schedules that indicate how many

subsidiaries DuPont owned between 1997 and 2001. (See Resp’t Br. at 16 (citing Resp’t

Des’g Evid., Confd’l Ex. 2M, Ex. 5 at 7-8).) The Department also states that “the buying

and selling of companies was so fundamental to . . . DuPont, it was included in [its] articles

of incorporation.” (See Resp’t Br. at 16 (citing Resp’t Des’g Evid., Ex. 2A at DIN 423).)

       When reviewing a motion for summary judgment, the Court construes all properly

asserted facts and reasonable inferences drawn therefrom in favor of the non-moving

party. See Scott Oil Co. v. Indiana Dep’t of State Revenue, 584 N.E.2d 1127, 1128-29

(Ind. Tax Ct. 1992). In its motion, the Department asks the Court to infer that DuPont’s

regular trade or business is buying and selling other businesses merely because the

number of subsidiaries it owned “fluctuated annually” and because its articles of

incorporation stated that it may purchase, sell, develop, and operate “lands and buildings.”

(See Resp’t Br. at 16; Resp’t Des’g Evid., Ex. 2A at DIN 423(d).)       This inference is not

reasonable in light of the fact that other evidence designated by both DuPont and the

Department demonstrates that DuPont is in the regular business of industrial, agricultural,

and chemical manufacturing. (See Pfeiffer Aff. ¶ 3; Pet’r Des’g Evid., Vol. III, Ex. 17; Pet’r

Des’g Evid., Vol. IV, Pelsor Tr. at 22, Fretts Tr. at 24.) (See also Resp’t Des’g Evid.,

Confd’l Ex. 8 at 4.)

       The designated evidence supports the reasonable inference that DuPont’s

manufacturing was its regular trade or business while its sale of any subsidiaries generally,

and DPC specifically, was not. (See, e.g., Resp’t Des’g Evid., Ex. 2A at DIN 422-23(a)-

                                             11
(c).)   See also W EBSTER’S THIRD NEW INT’L DICTIONARY 2279 (2002 ed.) (defining a

“subsidiary” as a corporation that “function[s] in the provision of aid, support, or other

benefit usu[ally] in a subordinate or inferior status or capacity”). As a result, the Court finds

that under the transactional test, DuPont’s gain was not business income.

        The second test used to determine whether income is business income is the

functional test, which comes from the second part of Indiana’s statutory business income

definition, i.e., that business income “‘includes income from tangible and intangible

property if the acquisition, management, and disposition of the property constitutes integral

parts of the taxpayer’s regular trade or business operations.’” May, 749 N.E.2d at 659

(citation omitted). Under this test, the gain received from the disposition of a capital asset

is business income if the asset was acquired, managed, and disposed of by the taxpayer

in its regular trade or business operations; the extraordinary nature or infrequency of the

sale is irrelevant. Id. at 659-60 (citations omitted).

        DuPont’s gain is business income under the functional test if DuPont’s acquisition,

management, and disposal of DPC was integral (i.e., necessary or essential) to its

manufacturing operations.      See id. at 664.       The Department claims the designated

evidence shows that:

           1) DuPont bought Merck’s interest in DMPC and formed DPC to
              enhance its competitiveness in the pharmaceutical sector, which it
              viewed as critical to its success;

           2) DuPont’s public filings indicated that both DPC and phamaceuticals
              were integral to its business; and

           3) DuPont sold DPC in response to changing market conditions, using
              the proceeds to enhance its profitability by buying back stock and
              paying down debt.



                                               12
(Resp’t Br. at 16 (citing Pfeiffer Aff. ¶¶ 14-16; Resp’t Des’g Evid., Ex. 1 (“1998”) at 3, 18;

Ex. 1 (“1999”) at 3, 5; Ex. 3 ¶ 19; Ex. 5 at 101, 104-05).) Accordingly, the Department

concludes that “[t]hroughout its entire existence, including through its sale, DPC was an

integral piece of DuPont’s business.” (Resp’t Br. at 16.)

       Even if it was reasonable to infer that DuPont both acquired and disposed of DPC

as an integral part of its manufacturing business, DuPont must also have managed DPC

as an integral part of its manufacturing business in order to characterize the gain as

business income. See May, 749 N.E.2d at 664 (emphasizing that all three factors – the

acquisition, the management, and the disposition of the property – must be met in order

for the functional test to be satisified). As previously indicated, however, the designated

evidence shows that DuPont played no role in the management of DPC; rather, DPC

operated as an independent, autonomous business. (See, e.g., Landgraf Aff. ¶ 29; Resp’t

Des’g Evid., Ex. 5 at 56-58.) Indeed, like its predecessor DMPC, DPC maintained its own

management team, its own research agenda and development facilities, its own

employees, its own profit objectives, and its own operating policies and procedures.

(Compare Pfeiffer Aff. ¶¶ 9-12 and Landgraf Aff. ¶¶ 17-18 with Landgraf Aff. ¶ 29 and

Resp’t Des’g Evid., Ex. 5 at 56-58.) Consequently, the gain from the sale of DPC does not

qualify as business income under the functional test either.

       The Court’s conclusion that DuPont’s gain is not apportionable business income

under Indiana Code § 6-3-1-20 is compatible with the result when applying the United

States Constitution’s unitary business principle standard. See, e.g., Allied-Signal, Inc. v.

Dir., Div. of Taxation, 504 U.S. 768, 786 (1992) (stating that the definitions of “business

income” and “non-business income” contained in UDITPA are “compatible” with the unitary

                                             13
business principle); supra, n.2 (explaining that the definitions of business and non-

business income under UDITPA and Indiana Code §§ 6-3-1-20 and -21 are the same).

The unitary business principle provides that a state “‘may tax an apportioned sum of [a]

corporation’s multistate business if the business is unitary.’”     MeadWestvaco Corp. v.

Illinois Dep’t of Revenue, 533 U.S. 16, 25 (2008) (citations omitted). A unitary business

relationship exists when corporate entities like DuPont and DPC are functionally

integrated, centrally managed, and benefit from economies of scale. See Allied-Signal,

504 U.S. at 781. See also Container Corp. of Am. v. Franchise Tax Bd., 463 U.S. 159,

180 n.19 (1983) (explaining that “a flow of value” serving an operational, rather than

investment, function is evidence of “functional integration,” while the presence of arm’s-

length transactions between two entities demonstrates a lack of integration, and that the

“occasional oversight . . . that any parent gives to an investment in a subsidiary” is not

evidence of centralized management); Exxon Corp. v. Wisconsin Dep’t of Revenue, 447

U.S. 207, 224 (1980) (explaining that economies of scale are present when business

entities share a centralized purchasing office “whose obvious purpose [is] to increase

overall corporate profits through bulk purchases and efficient allocation of supplies”).

       Here, the designated evidence does not show that DuPont and DPC were unitary.

First, but for some initial (i.e., “start-up”) flow of value between DuPont and DPC, DPC

operated independently of DuPont, and it paid DuPont arm’s-length rates for all services it

was provided. (Pet’r Des’g Evid., Vol. I., Aff. of Carmen Giannantonio (“Giannantonio Aff.”)

¶¶ 8-9, 39, 44-45, 47, Landgraf Aff. ¶ 29; Resp’t Des’g Evid., Ex. 5 at 56.) Second, there is

uncontradicted evidence that DuPont exercised no more than the “occasional oversight”

over DPC than would be typically afforded to an investor over his investment. (Compare

                                              14
Giannantonio Aff. ¶¶ 37, 54 and Pfeiffer Aff. ¶ 23 with Resp’t Br. at 17 (claiming that there

was centralized management merely because DuPont owned DPC).) Finally, there were

no economies of scale. (See Pfeiffer Aff. ¶ 26; Giannantonio Aff. ¶ 48 (explaining that

DuPont and DPC did not share any centralized purchasing whatsoever).)               Because

DuPont and DPC are not unitary, the unitary business principle directs that DuPont’s gain

on its sale of DPC is not apportionable business income.

                            III. Intercompany Interest Deductions

       The next issue is whether the Department erred when it disallowed the nearly $3.1

billion in interest expense deductions DuPont claimed on its 2006 and 2007 returns. (See,

e.g., Resp’t Des’g Evid., Ex. 3 ¶¶ 13, 17.) The Department disallowed the deductions on

the basis that the underlying loans lacked economic substance and were therefore sham

transactions. (See, e.g., Resp’t Br. at 7.)

       This Court has previously applied the federal economic substance doctrine to

determine whether a taxpayer's transactions lack economic substance. See, e.g., Elmer v.

Indiana Dep't of State Revenue, 42 N.E.3d 185, 191 (Ind. Tax Ct. 2015).           Under this

doctrine, “[t]he determination of whether a taxpayer’s transactions lacks economic

substance . . . requires the application of a two-pronged test: (1) was the taxpayer

motivated by any business purpose other than obtaining a tax benefit (the business

purpose test); and (2) did the transactions lack economic substance because no

reasonable possibility of a profit existed (the economic substance test).” Id. (citing Rice’s

Toyota World, Inc. v. C.I.R., 752 F.2d 89, 91 (4th Cir. 1985)). Here, the Department claims

that there can be neither a legitimate business purpose nor economic substance to a loan


                                              15
which is never repaid and whose sole effect was to “wipe out” DuPont’s Indiana income

through the interest expense deductions. (Resp’t Br. at 9.)

                                        A. Business Purpose

       The Department has merely alleged that Dupont’s loan transactions were used

solely to obtain the tax benefit associated with eliminating all of its Indiana taxable income.

(See Resp’t Br. at 9.)       In response, however, DuPont designated evidence that its

transactions with DEC and DGOI were part of a broader restructuring plan designed to

raise additional capital through a public stock offering. (See Schreiber Aff. ¶¶ 4-5; Pet’r

Des’g Evid., Vol. III., Exs. 13, 14).




                                   B. Economic Substance

       Next, the Department recites a litany of particulars to support its position that

Dupont’s loan transactions should be disregarded because they were structured without a

profit motive. More specifically, the Department argues that it properly disregarded the

loan transactions that lacked economic substance because: 1) DGOI had no receipts,

sales, or income by which it could have made its multi-billion dollar loans to DuPont; 2)

DuPont never made any payments on the Loans; and 3) the interest rates on the Loans

were “too high.” (See Resp’t Br. at 7-8, 11-13.) Moreover, the Department contends that

under Indiana Code §§ 6-3-2-2 and -20, it has the authority to “modify or disregard” the

transactions to reach their “true” economic substance. (See Resp’t Br. at 8; Pet’r Br. at 38

(citing Pet’r Des’g Evid., Vol. IV, Pelsor Tr. at 94-95, 97).) For the following reasons, the

Court disagrees.

                                               16
       First, the Department questions how DGOI could have made its multi-billion dollar

loans when it had no receipts, sales, or source of taxable income of its own beyond the

interest payments it received from its Loans.3 (See Resp’t Br. at 3, 8.) As Dupont has

explained, however, the original lender of the 1995 Loan was DEC, not DGOI. (See Pet’r

Br. Opp’n Resp’t Mot. Summ. J. & Reply Supp. Mot. Summ. J. (“Pet’r Reply Br.”) at 15.)

Dupont’s designated evidence shows that DEC had capital from its receipt of dividends

from the companies it owned, including Conoco, by which to make its loans.                  (See

Schreiber Aff. ¶ 3.) DuPont’s designated evidence also shows that not only did DGOI

receive a capital contribution of nearly $19 billion prior to making the 1999 Loan, but it had

sufficient cash flow after it made the 1999 Loan because Conoco paid DGOI more than $4

billion in principal and interest on other outstanding intercompany loans.          (See Aff. of

Noah Schrieber Supp. Pet’r Opp’n Resp’t Mot. Summ. J. ¶¶ 3-5, Ex. 1 (filed Dec. 16,

2015).) Thus, both DEC and DGOI were amply funded and able to loan money to DuPont.

       Second, the Department claims that the Loans lacked economic substance because

DuPont never made any interest or principal payments on them, merely rolling over the

outstanding liabilities on the maturity dates into new loans.          (See Res’p Br. at 8-9.)

Nonetheless, both Dupont’s and the Department’s designated evidence show that,

consistent with market practices, DuPont accrued the interest expense on its financial

statements and DGOI accrued the interest income. (See Assef Aff. ¶ 12; Resp’t Des’g


3
  The Department also states that DGOI paid no wages and thus had no employees. (See Resp’t
Br. at 3.) Dupont’s designated evidence and related argument demonstrate, however, that during
the years at issue DGOI had one employee. (See Pet’r Br. at 8 (citing Pet’r Des’g Evid., Vol. III,
Aff. of Sharon E. Smith ¶ 6).) To the extent the Department may have desired the Court to draw an
inference from the number of employees DGOI had, it failed to provide any cogent argument and
cite to any supporting evidence to that effect. (See Resp’t Br. at 7-13.)


                                               17
Evid., Ex. 3 ¶ 15, Ex. 4 (Petitioner’s Response to Respondent’s First Request for

Admissions at No. 8), Confd’l Ex. 8 at 8.) Accruals, for purposes of financial reporting, are

treated as if actual cash has been exchanged. See, e.g., BLACK’S LAW DICTIONARY 22 (9th

ed.) (defining “accounting method” as “[a] system for determining income and expenses,

profit and loss, asset value, appreciation and depreciation, and the like, esp. for tax

purposes”; defining “accrual accounting method” as “[a]n account method that records

entries of debits and credits when the revenue or liability arises, rather than when the

income is received or an expense is paid”). As a result, the Department has “cried wolf” by

implying that interest payments that exist merely as book entries, without money changing

hands, have no economic substance.

      Third, the Department maintains that the interest rates on the Loans were “too high”

and should have been refinanced. (See Resp’t Br. at 4, 12.) Nonetheless, DuPont’s

“common business practice [was] to ensure that all intercompany loans were made on an

arm’s[-]length basis, at market rates comparable to those that would have been available

from outside lenders.” (Pfeiffer Aff. ¶ 42.) To that end, the interest rates on the Loans

were established within the “safe haven range” prescribed by § 482 of the Internal

Revenue Code. (Assef Aff. ¶¶ 5-9, Ex. C (indicating that with respect to transactions

between related parties (e.g., intercompany transactions), I.R.C. § 482 indicates that an

interest rate within the safe haven range (i.e., between 100% and 130% of the applicable

federal rate (“AFR”)) is considered to be “arm’s-length” and thus at a market rate).)

Moreover, DuPont’s designated evidence shows not only that DuPont was not required to

refinance its Loans during their terms, but also that it most likely would not have been able




                                             18
to refinance at rates lower than those already applied to the Loans. (Assef Aff. ¶¶ 14-27,

29.)

       To the extent the Department has claimed that Indiana Code § 6-3-2-2(l) and (m)

authorize it to adjust Dupont’s Indiana tax base by disallowing Dupont’s interest

deductions, this Court has already explained that while Indiana Code § 6-3-2-2(l) permits

the Department to divide a taxpayer’s tax base differently than the Standard Sourcing

Rules (i.e., those contained in Indiana Code § 6-3-2-2(a) through (k)), it does not allow the

Department to adjust the taxpayer’s Indiana income tax base. See Columbia Sportswear

USA Corp. v. Indiana Dep’t of State Revenue, 45 N.E.3d 888, 896 (Ind. Tax Ct.

2015), review denied.     Moreover, the Court has previously noted the inescapeable

similarity between the text of Indiana Code § 6-3-2-2(m) and I.R.C § 482. See Rent-A-Ctr.

E., Inc. v. Indiana Dep’t of State Revenue, 42 N.E.3d 1043, 1050 (Ind. Tax Ct.

2015), review denied. As a result, § 482’s arm’s-length standard applies in determining

whether intercompany charges fairly reflect and report the income derived from Indiana

sources for purposes of applying the remedy under Indiana Code § 6-3-2-2(m). Because

the interest rates on Dupont’s loans were arm’s-length, supra, pp. 17-18, Indiana Code §

6-3-2-2(m) does not authorize the Department’s denial of Dupont’s interest expense

deductions.

       In addition, the Department maintains that Indiana Code § 6-3-2-20 permits it to

disallow DuPont’s interest deductions that are “directly related intangible interest

expenses,” (see, e.g., Resp’t Br. at 11-12; Resp’t Des’g Evid., Confd’l Ex. 8 at 15), the

plain language of the statute makes it clear that it applies to interest expenses related to

royalty, trademark, and copyright expenses or substantially similar types of intangible

                                             19
assets. See IND. CODE § 6-3-2-20(a)(2), (4), and (5) (2007). See also Caylor-Nickel Clinic,

P.C. v. Indiana Dep't of State Revenue, 569 N.E.2d 765, 768 (Ind. Tax Ct. 1991)

(explaining that the foremost goal of statutory construction is to determine and give effect

to the true intent of the legislature, which is embodied in the plain, ordinary, and usual

meaning of the statute’s words), aff'd, 587 N.E.2d 1311 (Ind. 1992).

       The Department’s arguments have failed to show that DuPont’s loan transactions

with DEC/DGOI lack economic substance. As a result, the Department’s disallowance of

DuPont’s interest expense deductions claimed on its 2006 and 2007 returns was improper.

                               IV. R&D Expense Deduction

       DuPont further claims that the Department erred when it disallowed its 2007 R&D

expense deduction. In 2007, DuPont incurred approximately $43 million in R&D expenses.

(Pet’r Des’g Evid., Vol. III, Aff. of Nolan S. Barrick (“Barrick Aff.”) ¶ 3.) DuPont deducted

these expenses on its Indiana return, but on audit the Department disallowed the

deduction because DuPont took a credit for them rather than a deduction at the federal

level. (Resp’t Des’g Evid., Confd’l Ex. 8 at 17.)

       For purposes of its 2007 federal income tax return, DuPont was entitled to take

either a deduction or a credit for its R&D expenses, but it was statutorily prohibited from

taking both. See generally I.R.C. §§ 41, 174, 280C(c)(1) (2007). DuPont took the credit.

(Barrick Aff. ¶ 4.) A federal R&D expense credit does not reduce a taxpayer’s federal

taxable income; rather, it reduces dollar-for-dollar the tax liability based on that federal

taxable income. See, e.g., BLACK’S LAW DICTIONARY at 475, 1599 (explaining generally that

a tax deduction reduces a taxpayer’s gross income to arrive at its taxable income, while a

                                              20
tax   credit   reduces   the   taxpayer’s    liability   on   that   taxable   income);    IRS,

https://www.irs.com/articles/tax-credits-vs-tax-deductions (last visited Jan. 30, 2017).

       DuPont’s election to take the federal R&D expense credit instead of the deduction

had a significant effect on how its R&D expenses were treated on its 2007 Indiana income

tax return. Indiana’s statutory scheme does not provide a state R&D expense deduction,

only an R&D credit. Compare IND. CODE §§ 6-3-2-.03 through -25 (2007) with IND. CODE

§§ 6-3.1-4-1 through -5 (2007).      An Indiana R&D expense deduction is unnecessary

because the starting place for reporting adjusted gross income on an Indiana income tax

return is federal taxable income, which already would have been reduced by the amount of

the R&D expenses if the federal deduction was elected. See, e.g., IND. CODE § 6-3-1-

3.5(b) (2007); Subaru-Isuzu, 782 N.E.2d at 1075.

       Here, DuPont did not take an R&D credit on its Indiana return, alleging that it was

not available. (See Pet’r Br. at 43 (citations omitted).) Moreover, DuPont’s federal taxable

income did not include the benefit of its R&D expenses. Nonetheless, DuPont deducted its

R&D expenses from the taxable income starting place reported on its Indiana return,

explaining that because “Indiana does not allow the federal R&D tax credit as part of its

corporate income tax starting point, [DuPont’s] actual R&D expenses . . . which would

otherwise be deductible for Federal income tax purposes, should be deductible in

calculating [its Indiana] corporate income tax base.” (Resp’t Des’g Evid., Confd’l Ex. 8 at

16 (emphasis added).) (See also Barrick Aff. ¶ 6; Resp’t Des’g Evid., Confd’l Ex. 2O at

DIN 806.) DuPont supports its deduction based on the Court’s previous explanation that

                                             21
          Indiana adjusted income begins with federal taxable income as defined
          by I.R.C. § 63, not as reported by the taxpayer. Thus, the issue is not
          what number appears on line 28 of a taxapyer’s federal income tax form
          1120 but whether a particular item of income was included in taxable
          income pursuant to I.R.C. § 63.

(Pet’r Br. at 43 (quoting Cooper Indus. v. Indiana Dep’t of State Revenue, 673 N.E.2d

1209, 1213 (Ind. Tax Ct. 1996)).)

       DuPont’s deduction, however, was improper for the following two reasons. First,

Indiana does not provide a specific deduction from the adjusted gross income tax base

(I.R.C. § 63 taxable income) for R&D expenses under Indiana Code § 6-3-1-3.5 or any

other statute. Second, DuPont’s election to take the federal R&D expense credit rather

the the federal R&D expense deduction carried with it a consequence: its I.R.C. § 63

taxable income cannot include a deduction for the same R&D expenses taken as a federal

credit. See I.R.C. § 208C(c)(1). Thus, based on the proper calculation of its taxable

income under I.R.C. § 63, without regard to what it reported on its federal tax return,

DuPont’s Indiana deduction was improper as a matter of law.




                                       V. 2007 Penalty

       Finally, DuPont argues that the Department had no basis for imposing the

negligence penalty against it for the 2007 tax year.            (See Pet’r Br. at 44.)       More

specifically, DuPont argues that the penalty was improper because it had reasonable

cause to believe that it properly completed its return given its interpretation of the

applicable Indiana tax law. (See Pet’r Br. at 44.)

       Indiana Code § 6-8.1-10-2.1 provides that a taxpayer is subject to a 10% penalty if

he fails to timely file his tax return, fails to pay his tax liability by the due date, or incurs a

                                                22
tax deficiency “due to negligence.”      IND. CODE § 6-8.1-10-2.1(a)-(b) (2007) (amended

2013). Nonetheless, the statute goes on to explain that

           [i]f a person subject to the penalty imposed under this section can show
           that the failure to file a return, pay the full amount of tax shown on the
           person’s return, timely remit tax held in trust, or pay the deficiency
           determined by the [D]epartment was due to reasonable cause and not
           due to willful neglect, the [D]epartment shall waive the penalty.

I.C. § 6-8.1-10-2.1(d). While the statute does not define “reasonable cause” or “willful

neglect,” one of the Department’s administrative regulations provides this guidance:

           “[n]egligence” on behalf of a taxpayer is defined as the failure to use
           such reasonable care, caution, or diligence as would be expected of an
           ordinary reasonable taxpayer. Negligence would result from a taxpayer’s
           carelessness, thoughtlessness, disregard or inattention to duties placed
           upon the taxpayer by the Indiana Code or [D]epartment regulations.
           Ignorance of the listed tax laws, rules and/or regulations is treated as
           negligence. . . . Negligence shall be determined on a case by case basis
           according to the facts and circumstances of each taxpayer.

                                             *****

           In order to establish reasonable cause, the taxpayer must demonstrate
           that it exercised ordinary business care and prudence in carrying out or
           failing to carry out a duty giving rise to the penalty imposed[.] . . .
           Reasonable cause is a fact sensitive question and thus will be dealt with
           according to the particular facts and circumstances of each case.

45 IND. ADMIN. CODE 15-11-2(b), (c) (2007).

      Based on the evidence before it, the Court finds that the portion of DuPont’s 2007

tax deficiency related to the nonbusiness/business income classification issue, as well as

the interest expense deduction issue, was incurred due to reasonable cause and not willful

neglect.    Indeed, DuPont has successfully litigated those two issues that affected the

computation of its 2007 AGIT liability; thus, its “differences in its interpretation of the

applicable Indiana tax law” were reasonably based, and the penalty attributable to those

issues should be waived.
                                              23
       The portion of DuPont’s 2007 tax deficiency that was related to its R&D expense

deduction was not successfully litigated.         Nonetheless, DuPont’s interpretation that

“taxable income” comprised anything that was includable under I.R.C. § 63 was not

unreasonable given the emphasis in Cooper decoupling what was includable in taxable

income from what was reported as taxable income on the federal return. To the extent the

Court has taken a broader view – that one must look beyond I.R.C. § 63 in determining

what is includable in “taxable income” – does not make DuPont’s view unreasonable or

due to willful neglect for purposes of the penalty. Consequently, the penalty related to that

issue is also waived.

                                       CONCLUSION

       For the aforementioned reasons, summary judgment is GRANTED to DuPont with

respect to issues II, III, and V. Summary judgment is GRANTED to the Department with

respect to issues I and IV.

       SO ORDERED this 11th day of July 2017.


                                                  Martha Blood Wentworth, Judge
                                                  Indiana Tax Court
DISTRIBUTION:

Francina A. Dlouhy, Daniel R. Roy, Hollis L. Hyans, Winston Lin




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