COLGATE-PALMOLIVE COMPANY v. COMMISSIONER OF REVENUE
Docket No. C255116 Promulgated:
April 3, 2003
This is an appeal under the formal procedure pursuant to G.L. c. 58A, § 7 and G.L. c. 62C, § 39 from the refusal of the appellee to abate corporate excise assessed against the appellant under G.L. c. 62C, § 26 and G.L. c. 63, § 38 for tax year 1988.
Commissioner Scharaffa heard the appeal and was joined in the decision for the appellant by Chairman Burns and Commissioner Rose.
These findings of fact and report are made at the request of the appellee pursuant to G.L. c. 58A, § 13 and 831 CMR 1.32.
John S. Brown, Esq., Joseph L. Kociubes, Esq., George P. Mair, Esq., Donald-Bruce Abrams, Esq., Darcy A. Ryding, Esq., and Matthew D. Schnall, Esq. for the appellant.
Lisa S. Mediano, Esq., Lutof G. Awdeh, Esq. and Thomas W. Hammond, Esq. for the appellee.
FINDINGS OF FACT AND REPORT
On the basis of a Statement of Agreed Facts and testimony and exhibits introduced at the hearing of this appeal, the Appellate Tax Board (“Board”) made the following findings of fact. The appellant, Colgate-Palmolive Company (“Colgate”) is a Delaware corporation. Colgate, as the principal reporting corporation, timely filed a combined corporate excise return for tax year 1988 (“the tax year at issue”). One of the subsidiaries included on this return was The Kendall Company (“Kendall”). Colgate had owned Kendall until October 31, 1988, when it sold all of its Kendall stock in a leveraged buyout. At all material times, Kendall was a Delaware corporation engaged in the business of manufacturing and selling medical and surgical supplies, including urological, incontinence, anesthesia, physical care, orthopedic, and vascular products and surgical dressings, for the health care industry. During 1988, Kendall’s principal place of business was in Mansfield, Massachusetts.1
Following an audit for the 1988 through 1990 calendar years, the Commissioner issued a Notice of Intent to Assess (“NIA”) dated November 11, 1995, which indicated the Commissioner’s intent to assess additional corporate excise for 1988. The Commissioner notified Colgate of an additional corporate excise assessment for 1988 by a Notice of Assessment (“NOA”) dated February 3, 1998. On March 4, 1998, Colgate paid in full the amount shown to be due in a February 7, 1998 NOA.2 On March 13, 1998, Colgate timely filed an application for abatement with the Commissioner, requesting abatement in the amount of $1,091,587 of tax plus interest. On August 13, 1999, Colgate withdrew its consent to extend the time for the Commissioner’s consideration of its application for abatement, and on August 17, 1999, Colgate timely filed its petition with the Board. On the basis of the above facts, the Board found it had jurisdiction over the appeal.
During the course of the audit, the contested issue was whether the Commissioner should have applied the “throwback” rule to the sales from thirty-three jurisdictions, thereby including those sales revenues in the numerator of Kendall’s sales factor.3 When Colgate originally filed its petition with the Board, it specified $79,971,542 in sales attributed to twenty-two of the thirty-three disputed jurisdictions, which resulted in $758,937 of additional corporate excise tax with the Commissioner’s application of the “throwback” rule to those sales.4 However, Colgate’s petition also referred to a second issue when it claimed that “some of the sales at issue were made to purchasers in states in which Kendall was taxable during 1988.” More generally, the petition also included language seeking “an abatement of the corporate excise tax and interest assessed against Colgate for the 1988 calendar year; and . . . for such other relief as may be fitting and proper.” At the close of the hearing, Colgate moved to amend its petition, arguing that
the testimony of two former sales employees of Kendall supported a ruling that none of the sales from the thirty-three jurisdictions at issue should have been “thrown back” to Massachusetts, because Kendall employees participated in activities that exceeded the solicitation of sales in all of the jurisdictions where it sold Kendall products and accordingly, Kendall had created a taxable nexus in all thirty-three jurisdictions at issue. The Board denied Colgate’s motion to amend its petition at the close of the hearing. However, for reasons which will be explained in the Opinion, the Board found that the “throwback” sales from all thirty-three jurisdictions were properly before the Board for its consideration.
The primary issue in this appeal was whether Kendall’s activities in the disputed jurisdictions were sufficient to subject Kendall to state taxation in those jurisdictions, thereby preventing the Commissioner from treating sales in these jurisdictions as Massachusetts sales under the “throwback” rule. Accordingly, the appellant had the burden of proving that its activities in the disputed jurisdictions exceeded the protection offered by Public Law 86-272, which prohibits state taxation of a corporation whose only presence in a taxing jurisdiction is the solicitation of orders. A secondary issue in this appeal was whether Kendall’s sales in twenty-three of the disputed jurisdictions were made by agents who were connected with offices located outside of the Commonwealth, thereby preventing the Commissioner from treating sales in these jurisdictions as Massachusetts sales under the “throwback” rule. The appellant also had the burden to prove that sales in question were made by Kendall sales representatives connected with an office located outside of the Commonwealth.
During the year at issue, Kendall employed various sales representatives who were responsible for regions throughout the country. During the hearing of this appeal, former Kendall representatives testified to and documented the placement and responsibilities of these many employees. The Board made the following findings with respect to these employees and their responsibilities.
Organization of Kendall’s sales force and distribution of Kendall’s products.
Cal H. Jones, an employee with Kendall from 1960 until his retirement in 1997, testified to the general organization of Kendall’s sales staff and the distribution of Kendall’s products during the tax year at issue. During 1984 and 1985, Mr. Jones served as a national sales manager involved in organizing, planning, and recruiting the Kendall sales staff nationwide. Mr. Jones then became the national hospital group’s contract manager from 1986 to 1987, responsible for negotiating contracts between Kendall and hospital buying groups for the sale of Kendall products. In 1987, Mr. Jones “went into the field” as an account manager, where he remained until his retirement in 1997. The Board found Mr. Jones to be a credible source of information on the organization of Kendall’s sales staff and the distribution of Kendall’s products.
Mr. Jones testified that during the tax year at issue, Kendall employed nationwide approximately two hundred sales representatives -- about a hundred account managers, and about eighty-eight or ninety product specialists. Account managers were responsible for selling the complete line of Kendall products, while product specialists were responsible for selling only certain of Kendall’s products for which they had developed a specialized knowledge through their training and experience with Kendall. Account managers and product specialists covered a specific territory and each reported to one of Kendall’s approximately twenty-five regional managers, who each covered a separate region of the country. Account managers, product specialists, and regional managers worked out of their homes.
Mr. Jones testified that product specialists were active in all of the regions throughout the country. Bobby Don Calvert, a former operating room specialist and eventually a district manager for Kendall, testified that, while Kendall may not have specifically assigned product specialists in a few “remote” areas of the country, “[s]omebody would always be ultimately responsible for” providing sales services in those geographical areas “all the way up to the zone director and the national sales manager . . . .” He testified that, as a market leader in sales of hospital products, it was “absolutely” Kendall’s intent to provide sales coverage throughout the entire country. He also testified that Kendall sold its hospital products to all of the hospitals nationwide, about 6,000 or 7,000 during the tax year at issue.
The Board found the testimony of both Mr. Jones and Mr. Calvert, a witness called by the Commissioner, to be credible. Considering that Kendall was a market leader in hospital products, the Board found it logical that Kendall would in fact assign its account managers and product specialists to specific territories throughout the country to facilitate sales in each of the thirty-three disputed jurisdictions. The Board also found that Colgate met its burden of proving that Kendall’s company policy was to provide sales coverage throughout the entire nation so that, even in those few “remote” areas, at least one sales manager was responsible for ensuring that someone was available to perform the same activities that Kendall routinely employed to sell its products.
Moreover, their testimonies were confirmed by a sales personnel directory produced at trial by Mr. Jones. According to this directory, as of July 1, 1988, at least twenty-one of the thirty-three jurisdictions in dispute had account managers who were directly based in the state,5 and at least twelve of those thirty-three jurisdictions also had product specialists who were directly based in the state.6 The Board found that the geographical placement of these sales representatives in various states throughout the country strongly confirmed Kendall’s intent to sell its products to hospitals nationwide.
In determining whether the activities of Kendall sales representatives in these jurisdictions were sufficient to create a taxable nexus, the Board considered testimony regarding the role of the sales representatives in the distribution of Kendall’s products. Mr. Jones explained that the distribution of Kendall’s products involved Kendall entering into contracts negotiated with hospitals or groups of hospitals organized as buying groups. These contracts gave Kendall a license to sell its products to the hospitals and fixed the prices for those products. However, the contracts did not commit the hospitals to purchase Kendall products over the products of any of its competitors, including Johnson & Johnson and C.R. Bard Company, which also entered into contracts with the same hospitals.
Approximately eighty percent of Kendall’s sales were accomplished by means of independent distributors,7 who purchased the products from Kendall and its competitors and sold them to the hospitals, which were the ultimate consumers of the products. Essentially, the independent distributors served a warehouse-like function for the hospital to store certain medical products. However, the contracts negotiated between Kendall and the hospitals did not guarantee that the hospitals would actually purchase Kendall products, nor did they prevent Kendall’s competitors from soliciting the same hospitals. Moreover, the independent distributors had no particular incentive to sell Kendall’s products over those of Kendall’s various competitors. As explained by Mr. Calvert, a witness for the Commissioner, “if you relied on the distributor to [sell Kendall’s product to the hospitals], they would be selling anything and everything that would give them the best margin.”
Therefore, because the prices of Kendall’s products were fixed by contract and independent distributors had no particular incentive to sell Kendall’s products, it was Kendall’s sales force that, as explained by Mr. Calvert, “generate[d] the pull” for its company’s products by visiting hospitals, promoting the value of their products over those of its competitors, and requesting that the customers fill out purchase orders with the independent distributors for Kendall’s products.8
The Board found credible the testimony of Mr. Jones and Mr. Calvert that, as part of Kendall’s regular company policy, Kendall sales employees engaged in several activities at the hospitals in each of the disputed jurisdictions in order to promote the sale of their products. These activities included: (1) demonstrations to doctors, nurses and purchasing agents of the benefits of Kendall’s products; (2) “in-service” advice regarding the proper use of Kendall products already purchased and in use at the hospitals; and (3) troubleshooting activities, which included investigating products in use when they malfunctioned. Additionally, sales personnel occasionally intervened in credit disputes with certain distributors. Each of these activities and their impact on Kendall’s taxability in the disputed jurisdictions are analyzed below.
Account managers and product specialists consistently and frequently visited individual hospitals in their sales territories in an effort to sell Kendall’s products. As explained by Mr. Jones, account managers and product specialists would regularly demonstrate the product to the nurses, doctors, or purchasing agents of the hospital and give free samples and informative brochures explaining the product in detail, which the hospital representatives could bring to the various purchasing committees. Mr. Calvert explained the activities involved in a typical product demonstration:
Well, if you were trying to get, say, the skin scrub tray business, what you would try to do is you would arrange with the operating room supervisor to maybe set up a station in the coffee room, bring donuts, and you would basically demonstrate the product to the surgeons and the nurses as they came in and out of surgery, and hopefully get them to order a trial order.
The Board found that one of the purposes of these on-site product demonstrations was for Kendall’s sales employees to offer technical assistance to the customer’s doctors and nurses on the proper use of Kendall’s highly specialized medical products. The Board further found that the rendering of technical advice on these products to the hospital employees responsible for using the products exceeded the act of merely requesting the hospital’s purchasing agents to make an order for the products. The Board thus found that the activities related to product demonstrations were not entirely ancillary to solicitation and accordingly that these activities were sufficient to subject Kendall to taxation in each of the disputed jurisdictions.
Mr. Calvert testified that Kendall sales personnel were encouraged to develop working relationships with key surgeons and key hospitals as a means of reaching their sales quotas. Mr. Jones and Mr. Calvert both testified that account managers and product specialists regularly accompanied doctors and nurses into the operating rooms and rendered “in-service” advice regarding the proper use of Kendall products that had already been purchased and were being used in the operating rooms. As explained by Mr. Jones and Mr. Calvert, product specialists and account managers would actually “scrub in,” enter the operating room, and actively demonstrate to the physicians how to use a Kendall product, for example, how to open a package of a surgical item and “present it into the sterile field” during a surgical procedure. Mr. Calvert testified that product specialists were specifically trained to render this technical advice and were expected to enter operating rooms routinely “to make sure that they use your product properly.”
The Board found that giving “in-service” advice on Kendall products already purchased and being used by the hospitals had an independent business purpose of rendering technical advice and therefore that they were not entirely ancillary to the solicitation of sales. Moreover, these activities were intended to facilitate sales in general rather than the solicitation of sales. Accordingly, the Board found that the activities related to “in-service” advice were sufficient to subject Kendall to taxation in each of the disputed jurisdictions.
Mr. Jones and Mr. Calvert also testified about Kendall sales personnel performing certain troubleshooting activities. For example, Kendall account managers and product specialists would call on hospitals to investigate claims of product malfunction and to follow-through on these claims by filling out forms for the customers and submitting them to Kendall’s quality assurance department. Mr. Jones explained how the nature of the relationship between the hospital and a Kendall sales representative created an understanding that the Kendall representative would be on-call and available to the hospital in the event that a product malfunctioned during a procedure:
Well, I mean, if we had a catheter that they inserted in the patient and the catheter couldn’t come out, who do you think they called? They called me and the specialist, and we had to get in there and find out why that catheter hasn’t deflated and what was the problem, was it defective, and we had to make out reports and replace it if necessary. (emphasis added).
Mr. Calvert echoed this testimony and further explained that the sales personnel were responsible for “mak[ing] sure that the offending product was pulled off the shelves” and following through with quality assurance procedures by filling out a product complaint form, collecting samples of the defective product and remitting the form and samples to Kendall’s product complaint department. He also explained that troubleshooting activities were considered to be part of the sales representatives’ job description, as Kendall managers believed this activity further enabled the sales representatives to meet their sales quotas.
The Board found that the performance of troubleshooting activities for Kendall products already purchased and being used by the hospitals was not entirely ancillary to the solicitation of sales. Instead, these activities were intended to improve Kendall’s relationship with its customers, thereby increasing sales in general. Moreover, the Board found that Kendall employed sales personnel to perform these activities, which could have been performed by quality assurance personnel apart from the sales force. The Board thus found that the activities related to troubleshooting were not entirely ancillary to solicitation and accordingly that these activities were sufficient to subject Kendall to taxation in each of the disputed jurisdictions.
Intervention in credit disputes
Kendall’s intended customers were the hospitals which ultimately used its products. However, pursuant to the arrangement of the hospitals with the independent distributors, Kendall supplied its products to these independent distributors, which in turn paid Kendall for the products.
Occasionally, Kendall would encounter problems with independent distributors not paying their invoices timely. Some evidence was offered suggesting that Kendall sales representatives assisted in the resolution of these credit claims. Mr. Calvert testified that for certain less-prominent distributors, such as “a small distributor in Louisiana,” a sales representative or the regional or district manager would be called upon to “get these people to pay or we’re going to shut them off.” However, the appellant offered no specific evidence regarding the extent to which sales representatives were involved in this dispute resolution process. Accordingly, the Board declined to make a finding regarding whether this activity was ancillary to the solicitation of sales or whether it subjected Kendall to taxation in the jurisdictions where the activities may have occurred. Because the Board found that the activities related to product demonstrations, “in-service” advice, and troubleshooting were sufficient to subject Kendall to taxation in each of the thirty-three disputed jurisdictions, a finding on this issue was not necessary to the outcome of this appeal.
Organization and operation of Kendall’s zone offices.
Colgate presented evidence to establish that Kendall conducted business through the operation of zone offices, a total of four during the tax period at issue with only one of those offices located in the Commonwealth. Mr. Jones testified that account managers and product specialists were assigned to specific, defined territories to provide sales coverage in each of the geographic sales locations. The account managers and product specialists each reported to one of approximately twenty-five regional managers, who were responsible for overseeing the sales activities of their specific geographical territories. Likewise, each regional manager reported to a zone manager who was responsible for an entire zone of sales territory. Mr. Jones explained that zone managers were responsible for managing the sales force in their respective zones, and they conducted their business in office buildings which were leased by Kendall.
Colgate presented evidence to establish that Kendall leased and operated four zone offices during the tax year at issue in the following locations: Mansfield, Massachusetts; Atlanta, Georgia; Barrington, Illinois; and Irvine, California. Mr. Jones testified that he was familiar with the zone offices and their functions during the tax year at issue, because his job at the time involved sales planning and recruiting to establish the zones. He testified that the zone offices each contained a suite of rooms, including an office for the zone manager, a separate, larger office space for the secretaries and the computers, copy machines and file cabinets, a board room for conferences, and a smaller room for more private meetings.
Zone managers operated from these leased zone offices and used them to conduct zone meetings of the entire sales team covering the territory within that zone. Mr. Jones explained that zone office meetings were held to focus on “how to increase our sales by utilizing the specialists and account managers as a team and individually to go out to the hospitals and get the business.” Mr. Jones testified that the frequency of the zone meetings varied, but he recalled attending at least four zone meetings during 1988. Mr. Jones also explained that regional meetings, which were held every few months and attended by a regional manager and the product specialists and account managers in that region, were sometimes held in the zone offices covering their region.
Colgate submitted into evidence a sales directory that Mr. Jones had retained from 1988, which Colgate’s counsel had just received within a week of the hearing before the Board. According to the sales directory, twenty-three of the thirty-three disputed jurisdictions were assigned to one of the three zone offices operating outside of the Commonwealth.9
The Commissioner disputed the existence during the tax year at issue of the fourth zone office in Atlanta and attempted to discredit the sales directory presented by Mr. Jones during the hearing. The Commissioner cited conflicting documents collected from the appellant during the audit phase of the appeal, particularly a document that had been prepared by John Henry, Kendall’s vice president of sales and no longer an employee of Colgate, which indicated that Kendall had operated only three zone offices during 1988, omitting the Atlanta zone office. However, Mr. Henry had prepared the document at the request of Colgate in 1995, about seven years after Colgate had sold its interests in Kendall. Moreover, Kendall closed the Atlanta office shortly after the close of 1988. Accordingly, Colgate explained that the discrepancy was a result of Colgate not having been involved in Kendall’s business for seven years and Mr. Henry being mistaken as to the closing date of the Atlanta zone office when he prepared the memorandum seven years after the tax year at issue.
Based on the testimony and evidence presented, including the sales directory from 1988, the Board found that Kendall operated the four zone offices in question during the tax year at issue. The Board also found that Colgate substantiated the assignment of territories to these zone offices.