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Genentech, Inc. v. Commissioner of Revenue

Supreme Judicial Court of Massachusetts, Suffolk

January 12, 2017


          Heard: October 7, 2016.

         Taxation, Corporate excise, Manufacturing corporation. Constitutional Law, Taxation, Commerce clause, Interstate commerce.

         Appeal from a decision of the Appellate Tax Board. The Supreme Judicial Court on its own initiative transferred the case from the Appeals Court.

          Catherine A. Battin, of Illinois (Richard C. Call also present) for the taxpayer.

          Brett M. Goldberg (Jamie E. Szal also present) for Commissioner of Revenue.

          Present: Gants, C.J., Botsford, Lenk, Hines, Gaziano, Lowy, & Budd, JJ.

          BOTSFORD, J.

         Under the Massachusetts corporate excise tax statute, G. L. c. 63, corporations that generate business income in Massachusetts and other States pay taxes on that income according to a statutory formula that seeks to apportion and tax the corporation's income generated in the Commonwealth. Beginning in 1996, for a "manufacturing corporation, " the apportionment formula has been based solely on the corporation's sales, see G. L. c. 63, § 38 (1), inserted by St. 1995, c. 280, § 2. The taxpayer Genentech, Inc., is a Delaware corporation with a principal place of business in California and earns business income in the Commonwealth as well as other States. In this appeal from a decision of the Appellate Tax Board (board), Genentech challenges the board's determination that it qualified as a manufacturing corporation for the tax years 1998 through 2004 (tax years at issue); it also challenges the board's rejection of its claim that application of § 38 (1) 's single-factor apportionment formula based on sales to the company violated the commerce clause of the United States Constitution. We affirm the decision of the board.


         We summarize the findings of fact made by the board. See G. L. c. 58A, § 13 ("The decision of the board shall be final as to findings of fact"). Genentech is a biotechnology company that develops drugs derived from proteins produced by living cells. Through a four-step process, Genentech employees modify the genetic codes of living cells to produce "proteins of interest" with desired pharmacologic effects.[1] First, Genentech scientists and other employees alter the deoxyribonucleic acid (DNA) of the selected cells to instruct them to produce a specific "protein of interest." Second, employees facilitate the production of the protein of interest by placing the genetically altered cells in successively larger tanks to enable growth and feeding them glucose and other nutrients while closely monitoring their environment. Third, the protein of interest is purified by separating it from the mix of cells and other material present through ultrafiltration and chromatography; Genentech must extract the protein from some cells by "disrupting" or breaking down the cell walls containing them. Finally, following the purification process, Genentech employees formulate the resulting bulk drug into its final dosage form, and package it for sale to distributors or directly to physicians, hospitals, and pharmacies around the world.

         On the financial side of Genentech's operations, the company invests excess cash in short-term securities -- money market funds, commercial paper, and treasury bonds. From two to seven employees working in Genentech's treasury department conduct a daily assessment of Genentech's cash needs and then liquidate short-term investments to free up cash or invest excess cash in short-term securities, as necessary. Money market funds are pooled investment vehicles that aim to maintain a consistent net asset value of one dollar per share. Consequently, investors generally expect to be able to redeem their shares for the amount originally invested, while also earning interest or dividends through the term that they hold shares in the money market fund. During the tax years at issue, the money market funds held in Genentech's accounts maintained a one dollar net asset value, thus allowing Genentech to redeem them for the purchase price.[2]

         Genentech's receipts pertaining to the transactions involving the short-term assets held in a number of Genentech's separate accounts in Mellon Bank established there were no capital gains or losses generated during the tax years at issue;[3]Genentech thus was able to either redeem the securities in every instance for the same amount as it paid for them, or hold the securities to maturity. Genentech did not include the proceeds it received from the redemption of its short-term securities in the statement of its revenue for purposes of the company's financial statements, in the computation of gross receipts reported on its Federal corporate income tax return that was used to determine its taxable income, or in the total of its receipts used to compute sales factor apportionment in filling out the company's California excise tax returns.

         Procedural history.

         For the tax years 1998 through 2003, Genentech filed its Massachusetts corporate excise returns using the three-factor apportionment formula based on property, payroll, and sales that applies to most general business corporations. See G. L. c. 63, § 38 (c.) .[4] For the 2004 tax year, Genentech originally filed its Massachusetts corporate excise tax return using the single-factor apportionment formula applicable to manufacturing corporations, but later filed an application for abatement, claiming that it was not substantially engaged in manufacturing and thus should have been entitled to apportion its income on the standard three-factor basis.

         The commissioner of revenue (commissioner) issued four notices of assessment to Genentech, taking the position that Genentech was engaged in substantial manufacturing activity for all the tax years at issue and thus required to use the single-factor apportionment formula in § 38 (1.) . Genentech filed several applications for abatement, all of which the commissioner denied. Genentech timely filed petitions under formal procedure with the board for each denial. The board ruled that Genentech was engaged in manufacturing for purposes of § 38 (1.), that its manufacturing activities were "substantial [], " as required by § 38 (1), and that application of the single-factor apportionment formula to the company did not violate the commerce clause. Genentech filed a timely appeal, and we transferred the case from the Appeals Court to this court on our own motion.

         Standard of review.

         "A decision by the board will not be modified or reversed if the decision 'is based on both substantial evidence and a correct application of the law.'" Capital One Bank v. Commissioner of Revenue, 453 Mass. 1, 8, cert, denied, 557 U.S. 919 (2009), quoting Boston Professional Hockey Ass'n v. Commissioner of Revenue, 443 Mass. 276, 285 (2005). "Because the board is authorized to interpret and administer the tax statutes, its decisions are entitled to deference. . . . Ultimately, however, the interpretation of a statute is a matter for the courts" (citation omitted). Onex Communications Corp. v. Commissioner of Revenue, 457 Mass. 419, 424 (2010).


         1. Genentech's manufacturing.

         During the tax years at issue, a "manufacturing corporation" was defined in § 38 (1.) (1) in relevant part as follows:

"In order to be engaged in manufacturing, the corporation must be engaged, in substantial part, in transforming raw or finished physical materials by hand or machinery, and through human skill and knowledge, into a new product possessing a new name, nature and adapted to a new use."[5]

         This court has considered whether particular activities conducted by a corporation qualify as "manufacturing" in a number of different factual contexts.[6] We start with the premise that a critical component of manufacturing is "the implication of change wrought through the application of forces directed by the human mind, which results in the transformation of some preexisting substance or element into something different, with a new name, nature or use." Boston & Me. R.R. v. Billerica, 262 Mass. 439, 444-445 (1928). See William F. Sullivan & Co. v. Commissioner of Revenue, 413 Mass. 576, 579 (1992) ("our decisions have embraced the basic concept of manufacturing articulated in Boston & Me. R.R [supra]"); The Charles River Breeding Labs., Inc. v. State Tax Comm'n, 374 Mass. 333, 335 (1978) ("Manufacturing normally involves a change of some substance, element, or material into something new or different").

         In cases where this court has determined that a company's activities did not qualify as manufacturing, we have noted the absence of new products "of substantially different character" (citation omitted). Tilcon-Warren Quarries, Inc. v.Commissioner of Revenue, 392 Mass. 670, 673 (1984). In that case, for example, we concluded that extracting rocks from the ground and crushing them into smaller, commercially usable sizes did not involve a change in the material's character necessary to qualify as manufacturing. See Id. at 672-673. Similarly, the breeding and raising of partially uncontaminated laboratory animals was determined not to be manufacturing because "[m]anufacturing normally involves a change of some substance, element, or material into something new or different [and] [n]o matter how intricately ...

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