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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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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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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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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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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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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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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