Supreme Court Case Analysis: HANS REES' SONS, Inc. v. NC - Law Module

This case study analyzes the Supreme Court case of HANS REES' SONS, Inc. v. STATE OF NORTH CAROLINA, which involved a dispute over the allocation of corporate income for state tax purposes. The case examines the constitutionality of North Carolina's income tax statute as applied to the appellant, a New York corporation engaged in tanning and manufacturing leather. The central issue revolves around whether the state's method of apportioning income, based on the value of property within the state, was arbitrary and violated the Commerce Clause and the 14th Amendment. The appellant argued that the allocation did not accurately reflect the income generated within North Carolina, while the state maintained that its method was reasonable. The Supreme Court upheld the state's tax, referencing prior cases such as Underwood Typewriter Co. v. Chamberlain and Bass, Ratcliff & Gretton v. State Tax Commission, which established precedents for state taxation of interstate businesses. The court found that the appellant failed to demonstrate that the apportionment method resulted in an unreasonable outcome or violated constitutional rights. The case provides valuable insights into the complexities of state taxation of interstate commerce and the application of constitutional limitations.

HANS REES' SONS, Inc., Appt. v. STATE OF NORTH
CAROLINA ON THE RELATION OF ALLEN J. MAXWELL,
COMMISSIONER OF REVENUE
Case Information:
Docket/Court: 334, U.S. Supreme Court
Date Issued: 04/13/1931 Argued March 18, 1931.
Tax Type(s): Corporate Income Tax
Cite: 283 US 123 , 51 S Ct 385 , 75 L Ed 879
OPINION
Mr. Chief Justice Hughes delivered the opinion of the court:
The appellant, Hans Rees' Sons, Inc., a corporation organized under the laws of New York,
began this action by an application to the commissioner of revenue of the state of North Carolina
for the readjustment of the income tax assessed against the appellant by that state. The
assessment was for the years 1923, 1924, 1925 and 1926, in accordance with the applicable
state laws, 1 and the controversy related to the proper allocation of income to the state of North
Carolina. The commissioner of revenue made his findings of fact and conclusions of law, the
appellant's exceptions were overruled and the prayer for revision of the taxes was disallowed.
Appeal, waiving a jury, was taken to the superior court of Buncombe county, North Carolina. On
the trial in that court, evidence was introduced by the appellant with respect to the course of
business and the amount and sources of income for the years in question. The appellant admitted
that "(a) in assessing the tax the commissioner of revenue followed the statutory method ...; (b)
that the valuation of the real estate and tangible property of the taxpayer 'both within and without
the state' is correct; (c) that the total net income used as a basis for the calculation of the tax is
correct: (d) that the allocation of the net income for purposes of taxation was in full accord with
the statute." The contention of the appellant was that the income tax statute as applied to the
appellant, upon the facts disclosed, was arbitrary and unreasonable, and was repugnant to the
commerce clause and to § 1 of the 14th Amendment of the Federal Constitution. The superior

court struck out the testimony offered by the appellant, as being immaterial, and held that the
statute as applied did not violate constitutional rights. The judgment dismissing the action was
affirmed by the supreme court of the state, 199 N. C. 42 , 153 S. E. 850. The case comes here on
appeal.
As to the portions of the taxes for the years in question, which had been paid by the appellant
voluntarily and as to which recovery was denied upon that ground, no question is raised here.
[1] The supreme court of the state sustained the ruling of the trial court in striking out the
evidence offered by the appellant, but held that, if the evidence were deemed to be competent, it
would not change the result. The case may therefore be viewed as though the evidence had been
received and held to have no bearing on the validity of the statute. Fairmont Creamery Co. v.
Minnesota, 274 U. S. 1, 5, 71 L. ed. 893, 895, 52 A.L.R. 163, 47 S. Ct. 506 . The evidence was
thus summarized by the state court:
"This evidence tended to show that the petitioner" (the appellant here) "was incorporated in the
state of New York in 1901 and is engaged in the business of tanning, manufacturing and selling
belting and other heavy leathers. Many years prior to 1923 it located a manufacturing plant at
Asheville, North Carolina, and after this plant was in full operation dismantled and abandoned all
plants which it had heretofore operated in different states of the union. The business is conducted
upon both wholesale and retail plans. The wholesale part of the business consists in selling
certain portions of the hide to shoe manufacturers and others in carload lots. The retail part of the
business consists in cutting the hide into innumerable pieces, finishing it in various ways and
manners and selling it in less than carload lots. In order to facilitate sales a warehouse is
maintained in New York from which shipments are made of stock on hand to various customers.
The tannery at Asheville is used as a manufacturing plant and a supply house, and when the
quantity or quality of merchandise required by a customer is not on hand in the New York
warehouse a requisition is sent to the plant at Asheville to ship to the New York warehouse or
direct to the customer. The sales office is located in New York and the salesmen report to that
office. Sales are made throughout this country and in Canada and Continental Europe. Some
sales are also made in North Carolina. Certain finishing work is done in New York. The evidence
further tended to show that 'between 40 and 50 per cent of the output of the plant in Asheville is

shipped from the Asheville tannery to New York. The other 60 per cent is shipped direct on orders
from New York. ... Shipment is made direct from Asheville to the customer.'
"The petitioner also offered evidence to the effect that the income from the business was derived
from three sources, to wit: (1) Buying profit; (2) manufacturing profit; (3) selling profit. It contends
that buying profit resulted from unusual skill and efficiency in taking advantage of fluctuations of
the hide market; that manufacturing profit was based upon the difference between the cost of
tanning done by contract and the actual cost thereof when done by the petitioner at its own plant
in Asheville, and that selling profit resulted from the method of cutting the leather into small parts
so as to meet the needs of a given customer.
"Without burdening this opinion with detailed compilations set out in the record, the evidence
offered by the petitioner tends to show that for the years 1923, 1924, 1925, and 1926, the
average income having its source in the manufacturing and tanning operations within the state of
North Carolina was 17 per cent."
According to the assessments in question, as revised by the commissioner of revenue and
sustained, there was allocated to the state of North Carolina, pursuant to the prescribed statutory
method, for the year 1923, 83+ per cent of the appellant's income; for 1924, 85+ per cent; for
1925, 66+ per cent; and for 1926, 85+ per cent.
The applicable statutory provisions, as set forth by the state court, are as follows:
"Every corporation organized under the laws of this state shall pay annually an income tax,
equivalent to four per cent of the entire net income as herein defined, received by such
corporation during the income year; and every foreign corporation doing business in this state
shall pay annually an income tax equivalent to four per cent of a proportion of its entire income to
be determined according to the following rules:
“(a) In case of a company other than companies mentioned in the next succeeding
section, deriving profits principally from the ownership, sale or rental of real estate or from
the manufacture, purchase, sale of, trading in, or use of tangible property, such
proportion of its entire net income as the fair cash value of its real estate and tangible
personal property in this State on the date of the close of the fiscal year of such company

in the income year is to the fair cash value of its entire real estate and tangible personal
property then owned by it, with no deductions on account of encumbrances thereon.
“(b) In case of a corporation deriving profits principally from the holding or sale of
intangible property, such proportion as its gross receipts in this state for the year ended
on the date of the close of its fiscal year next preceding is to its gross receipts for such
year within and without the state.
“(c) The words 'tangible personal property' shall be taken to mean corporeal personal
property, such as machinery, tools, implements, goods, wares and merchandise and
shall not be taken to mean money deposits in bank, shares of stock, bonds, notes, credits
or evidence of an interest in property and evidences of debt."
Relying upon the decisions of this court with respect to statutes of a similar sort enacted by other
states, the supreme court of the state held that the statute of North Carolina was not invalid upon
its face.Underwood Typewriter Co. v. Chamberlain, 254 U. S. 113, 120, 121, 65 L. ed. 165, 169,
170, 41 S. Ct. 45; Bass, Ratcliff & Gretton v. State Tax Commission, 266 U. S. 271, 280-283, 69
L. ed. 282, 286-288, 45 S. Ct. 82 ; National Leather Co. v. Massachusetts, 277 U. S. 413, 423 ,
72 L. ed. 935, 938, 48 S. Ct. 534 . In Underwood Typewriter Co. v. Chamberlain, 254 U. S. 113,
65 L. ed. 165, 41 S. Ct. 45, supra, a statute of Connecticut imposed upon foreign corporations
doing business partly within and partly without the state, an annual tax of two per cent upon the
net income earned during the preceding year on business carried on within the state, ascertained
by taking such proportion of the whole net income on which the corporation was required to pay a
tax to the United States as the value of its real and tangible personal property within the state
bore to the value of all its real and tangible personal property. All the manufacturing by the
corporation was done in Connecticut, but the greater part of its sales were made from branch
offices in other states. It was contended that the tax was an unconstitutional burden upon
interstate commerce and that it violated the 14th Amendment in that it imposed a tax on income
arising from business conducted without the state. In support of the latter objection, the
corporation showed that while 47 per cent of its real estate and tangible personal property was
located in Connecticut, almost all its net profits were received in other states. This court said: "But
this showing wholly fails to sustain the objection. The profits of the corporation were largely
earned by a series of transactions beginning with manufacture in Connecticut and ending with
sale in other states. In this it was typical of a large part of the manufacturing business conducted

in the state. The legislature in attempting to put upon this business its fair share of the burden of
taxation was faced with the impossibility of allocating specifically the profits earned by the
processes conducted within its borders. It, therefore, adopted a method of apportionment which
for all that appears in this record, reached, and was meant to reach, only the profits earned within
the state. 'The plaintiff's argument on this branch of the case,' as stated by the supreme court of
errors, 'carries the burden of showing that 47 per cent of its net income is not reasonably
attributable, for purposes of taxation, to the manufacture of products from the sale of which 80 per
cent of its gross earnings was derived after paying manufacturing costs.' The corporation has not
even attempted to show this; and for aught that appears the percentage of net profits earned in
Connecticut may have been much larger than 47 per cent. There is, consequently, nothing in this
record to show that the method of apportionment adopted by the state was inherently arbitrary, or
that its application to this corporation produced an unreasonable result." In this view, the validity
of the Connecticut statute was sustained.
In the case of Bass, Ratcliff & Gretton v. State Tax Commission, 266 U. S. 271 , 69 L. ed. 282,
45 S. Ct. 82, supra, the state of New York imposed an annual franchise tax at the rate of 3 per
cent upon the net income of the corporation. The court, describing the statute, said that "if the
entire business of the corporation is not transacted within the state, the tax is to be based upon
the portion of such ascertained net income determined by the proportion which the aggregate
value of specified classes of the assets of the corporation within the state bears to the aggregate
value of all such classes of assets wherever located." The corporation in that case was British,
engaged in brewing and selling Bass' ale. Its brewing was done, and a large part of its sales were
made, in England, but it had imported a portion of its product into the United States which it sold
in branch offices located in New York and Chicago. The court regarded the question of the
constitutional validity of the New York tax as controlled in its essential aspect by the decision in
Underwood Typewriter Co. v. Chamberlain, 254 U. S. 113, 65 L. ed. 165, 41 S. Ct. 45, supra.
And, referring to the facts of that case, the court said: "So in the present case we are of opinion
that, as the company carried on the unitary business of manufacturing and selling ale, in which its
profits were earned by a series of transactions beginning with the manufacture in England and
ending in sales in New York and other places—the process of manufacturing resulting in no
profits until it ends in sales—the state was justified in attributing to New York a just proportion of
the profits earned by the company from such unitary business. ... Nor do we find that the method
of apportioning the net income on the basis of the ratio of the segregated assets located in New

York and elsewhere, was inherently arbitrary or a mere effort to reach profits earned elsewhere
under the guise of legitimate taxation. ... It is not shown in the present case, any more than in the
Underwood Typewriter Co. Case, that this application of the statutory method of apportionment
has produced an unreasonable result."
In the instant case, the state court, having considered these decisions, held that the statute of
North Carolina was valid upon its face, sought to justify its view that the evidence offered by the
appellant was without effect, upon the following grounds:
"The fallacy of this conclusion" (that is, the appellant's contention that the
application of the statute had been shown to be unreasonable and arbitrary, and
hence repugnant to the Federal Constitution) "lies in the fact that the petitioner
undertakes to split into independent sources, income which the record discloses
was created and produced by a single business enterprise. Hides were bought for
the purpose of being tanned and manufactured into leather at Asheville, North
Carolina, and this product was to be shipped from the plant and sold and distributed
from New York to the customer. The petitioner was not exclusively a hide dealer or
a mere tanner of leather or a leather salesman. It was a manufacturer and seller of
leather goods, involving the purchase of raw material and the working up of that raw
material into acceptable commercial forms, for the ultimate purpose of selling the
finished product for a profit. Therefore, the buying, manufacturing and selling were
component parts of a single unit. The property in North Carolina is the hub from
which the spokes of the entire wheel radiate to the outer rim." And, in its final
conclusion, the state court said that, if it were conceded that the evidence offered by
the appellant was competent, still, as it showed that the appellant "was conducting a
unitary business as contemplated and defined by the courts of final jurisdiction," it
was "not permissible to lop off certain elements of the business constituting a single
unit, in order to place the income beyond the taxing jurisdiction of this state."
We are unable to agree with this view. Evidence which was found to be lacking in the Underwood
Typewriter Co. and Bass, Ratcliff & Gretton Cases is present here. These decisions are not
authority for the conclusion that where a corporation manufactures in one state and sells in
another, the net profits of the entire transaction, as a unitary enterprise, may be attributed,

regardless of evidence, to either state. In the Underwood Typewriter Co. Case, it was not decided
that the entire net profits of the total business were to be allocated to Connecticut because that
was the place of manufacture, or, in the Bass, Ratcliff & Gretton Case, that the entire net profits
were to be allocated to New York because that was the place where sales were made. In both
instances, a method of apportionment was involved which, as was said in the Underwood
Typewriter Co. Case, "for all that appears in the record, reached, and was meant to reach, only
the profits earned within the state." The difficulty with the evidence offered in the Underwood
Typewriter Co. Case was that it failed to establish that the amount of net income with which the
corporation was charged in Connecticut under the method adopted was not reasonably
attributable to the processes conducted within the borders of that state; and in the Bass, Ratcliff &
Gretton Case the court found a similar defect in proof with respect to the transactions in New
York.
[2] Undoubtedly, the enterprise of a corporation which manufactures and sells its manufactured
product is ordinarily a unitary business, and all the factors in that enterprise are essential to the
realization of profits. The difficulty of making an exact apportionment is apparent and hence,
when the state has adopted a method not intrinsically arbitrary, it will be sustained until proof is
offered of an unreasonable and arbitrary application in particular cases. But the fact that the
corporate enterprise is a unitary one, in the sense that the ultimate gain is derived from the entire
business, does not mean that for the purpose of taxation the activities which are conducted in
different jurisdictions are to be regarded as "component parts of a single unit" so that the entire
net income may be taxed in one state regardless of the extent to which it may be derived from the
conduct of the enterprise in another state. As was said in the Bass, Ratcliff & Gretton Case with
regard to "the unitary business of manufacturing and selling ale" which began with manufacturing
in England and ended in sales in New York, that state "was justified in attributing to New York its
proportion of the profits earned by the company from such unitary business." And the principle
that was recognized in National Leather Co. v. Massachusetts, 277 U. S. 413, 72 L. ed. 935, 48
S. Ct. 534, supra, was that a tax could lawfully be imposed upon a foreign corporation with
respect to "the proportionate part of its total net income which is attributable to the business
carried on within the state." When, as in this case, there are different taxing jurisdictions, each
competent to lay a tax with respect to what lies within, and is done within, its own borders, and
the question is necessarily one of apportionment, evidence may always be received which tends

to show that a state has applied a method, which, albeit fair on its face, operates so as to reach
profits which are in no just sense attributable to transactions within its jurisdiction.
Nor can the evidence be put aside in the view that it merely discloses such negligible criticisms in
allocation of income as are inseparable from the practical administration of a taxing system in
which apportionment with mathematical exactness is impossible. The evidence in this instance,
as the state court puts it, "tends to show that for the years 1923, 1924, 1925, and 1926, the
average income having its source in the manufacturing and tanning operations within the state of
North Carolina was 17 per cent," while under the assessments in question, there was allocated to
the state of North Carolina approximately 80 per cent of the appellant's income.
An analysis has been submitted by the appellant for the purpose of showing that the percentage
of its income attributable to North Carolina, for the years in question, did not in any event exceed
21.7 per cent. As pointed out by the state court, the appellant's evidence was to the effect that the
income from its business was derived from three sources, buying profit, manufacturing profit, and
selling profit. The appellant states that its sales were both wholesale and retail; that the profits
from the wholesale business were in part attributable to the manufacturing in Asheville and in part
to the selling in New York, but that the appellant's accountants made no attempt to separate this,
and that the entire wholesale profit was credited to manufacturing and allocated to North
Carolina. Similarly, it is said that no attempt was made to separate profits from manufacturing in
New York from profits derived from manufacturing in Asheville, and that all manufacturing profits
were allocated to North Carolina. It is insisted that, in the retail part of the business, the leather is
cut into small pieces and finished in particular ways and supplied in small lots to meet the
particular needs of individual customers, and that this part of the business is essential to the retail
merchandising business conducted from the New York office. The so- called "buying profit" is
said to result from the skill with which hides are bought and the contention is that these buying
operations were not conducted in North Carolina. If as to the last, it be said that the buying of raw
material for the manufacturing plant should be regarded as incident to the manufacturing
business, and as reflected in the value at wholesale of the manufactured product as turned out at
the factory, still it is apparent that the amount of the asserted buying profit is not enough to affect
the result so far as the constitutional question is concerned.

[3] For the present purpose, in determining the validity of the statutory method as applied to the
appellant, it is not necessary to review the evidence in detail, or to determine as a matter of fact
the precise part of the income which should be regarded as attributable to the business
conducted in North Carolina. It is sufficient to say that, in any aspect of the evidence, and upon
the assumption made by the state court with respect to the facts shown, the statutory method, as
applied to the appellant's business for the years in question, operated unreasonably and
arbitrarily, in attributing to North Carolina a percentage of income out of all appropriate proportion
to the business transacted by the appellant in that state. In this view, the taxes as laid were
beyond the state's authority. Shaffer v. Carter, 252 U. S. 37 , 52, 53, 57, 64 L. ed. 445, 456, 457,
40 S. Ct. 221.
For this reason the judgment must be reversed and the cause remanded for further proceedings
not inconsistent with this opinion.
It is so ordered.
1
Laws 1923, chap. 4, § 201; 1925, chap. 101, § 201; 1927, chap. 80, § 311.
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