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FIRST DIVISION
November 13, 2000

JUSTICE O'MARA FROSSARD delivered the opinion of the court:

Plaintiff, Home Interiors & Gifts, Inc., appeals the order of the circuit court affirming theDepartment of Revenue's (Department) finding that plaintiff owes taxes on interest income it earnedin 1989 and 1990. In 1993, the Department issued to plaintiff a notice of business income taxdeficiency. The Department determined that plaintiff's corporate tax returns for the years of 1989and 1990 should be adjusted to reflect certain interest income plaintiff earned from short-terminvestments in those years. Plaintiff filed a protest, and the parties submitted a stipulation of factsto an administrative law judge (ALJ). The ALJ recommended that plaintiff owed additionalcorporate taxes for the years of 1989 and 1990, finding that all the interest income from plaintiff'sshort-term investments constituted apportionable business income. The Director of the Departmentadopted this recommendation. Plaintiff then sought administrative review of the Director's decision. The circuit court affirmed the Director's decision. On appeal, plaintiff argues that imposition of theIllinois income tax on its entire interest income from its short-term investment accounts violates thedue process clause and the commerce clause of the United States Constitution.

The parties stipulated to the following facts. Plaintiff is a Texas corporation that sellswholesale home decorative accessories nationwide. In 1989 and 1990, plaintiff generated sufficientcash to sustain its business operation and, as a result, had modest working capital requirements andno need to borrow funds from outside sources. Plaintiff invested its excess capital in long-term andshort-term investments. During 1989 and 1990, plaintiff purposefully invested in short-termsecurities, because it was waiting for more favorable developments in long-term money markets andthe Texas commercial real estate market.

Plaintiff maintained its short-term investments in five accounts: Coppell Bank, Small Bank,Municipal Bank, Bank One, and Salomon Brothers. Each account earned plaintiff interest income,and plaintiff reported these accounts as investments on its balance sheet. On both its Texasfranchise returns and its Illinois corporate income taxes for years 1989 and 1990, plaintiff reportedthis interest income as allocable only to Texas. The Department acknowledged that the interest fromthe Salomon Brothers account was not apportionable, because this account was not designated oravailable as working capital and was never used in plaintiff's trade or business.

The parties stipulated the following about the funds in the four other short-term investmentaccounts: "the funds from these general accounts were utilized in part as working capital reserve. None of these funds were *** designated for a particular use, and all of the funds were available foruse in the day to day business operations of the [plaintiff]."

In 1989 and 1990, the four investment accounts at issue generated interest income of$7,681,334 and $11,017,682. The Department sought to tax all this income as apportionable. Plaintiff claimed that only a portion of the income was apportionable. The parties then stipulatedto the results of a formula created by plaintiff which calculated the greatest percent invasion intoeach account for each year to determine the amount of interest income that was attributable to its useof the funds and constituted business income. The Department agreed with the formula but objectedto whether "any methodology can bifurcate an account to clearly reflect that portion is used in thebusiness and generates business income and that portion is not used in the business and generatesnon-business income that is not apportionable." Applying plaintiff's formula, the parties stipulatedthat if only a portion of Home Interiors' income from its four investments is to be apportioned, theamounts of income to be apportioned are $1,912,652.17 in 1989 and $1,650,448.80 in 1990.

The ALJ found that plaintiff regularly invested its excess cash in short-term accounts andconsidered these accounts as working capital reserve. The ALJ also rejected plaintiff's formula fordetermining the amount of interest income that was apportionable. The ALJ believed that becauseplaintiff "admitted that these [short-term investment] funds were used for working capital," then allthe interest income constituted business income apportionable to Illinois. The Director of theDepartment adopted the ALJ's decision that all of the interest income from Home Interiors' fourinvestments is apportionable business income and the circuit court affirmed. The circuit court firstfound that plaintiff's entire interest income in the short-term accounts constituted business incomeunder the Illinois Income Tax Act (35 ILCS 5/1501(a)(1) (West 1998)). The circuit court nextrejected plaintiff's constitutional claim. The circuit court found that because plaintiff invested thesefunds in accounts "used for working capital" and that this undivided income was the source of "fundsnecessary for day-to-day operations," it had failed to meet its burden to establish that only a portionof the income was apportionable. The circuit court characterized plaintiff's formula as "conceptuallyflawed" and, like the ALJ, rejected it. This appeal followed.

On appeal, plaintiff only asserts its constitutional claim. Plaintiff argues that the due processand commerce clauses give Illinois the authority to tax only the interest income in the short-terminvestments accounts that plaintiff used as working capital. Therefore, according to plaintiff, onlythe income identified by its formula as being used as working capital is apportionable ($1,912,652.17in 1989 and $1,650,448.80 in 1990). The Department counters that, because all the funds in theshort-term investment accounts were available for plaintiff's business operations, all the incomefrom these accounts is subject to the Illinois business income tax and is apportionable.

Under the Administrative Review Law (735 ILCS 5/3-101 et seq. (West 1998)), we reviewthe final decision of the administrative agency and not the decision of the circuit court. Richard'sTire Co. v. Zehnder, 295 Ill. App. 3d 48, 56 (1998). While the reviewing court defers to the agency'sfindings of fact (735 ILCS 5/3-110 (West 1998)), it conducts an independent review of itsconclusions of law. County of Cook v. Licensed Practical Nurses Ass'n of Illinois, Division I, 284Ill. App. 3d 145, 152 (1996). When the agency decides a mixed question of law and fact, we reviewits decision under a clearly erroneous standard. City of Belvidere v. Illinois State Labor RelationsBoard, 181 Ill. 2d 191 (1998). When the issue on appeal is one of law only and involves no questionof fact, we review the agency's decision de novo. Rockwood Holding Co. v. Department of Revenue,312 Ill. App. 3d 1120, 1123 (2000).

Relying on City of Belvidere, the Department argues that we should apply the clearlyerroneous standard. In City of Belvidere, the issue raised was whether the city's refusal to engagein collective bargaining constituted an unfair labor practice pursuant to the Illinois Public LaborRelations Act (Act) (5 ILCS 315/1 et seq. (West 1998)); City of Belvidere, 181 Ill. 2d at 202. Thecourt found that the agency's decision required it to make both a factual determination of the city's practices and a legal interpretation of the Act. The court held that because the agency's decisioninvolved a mixed question of law and fact, the clearly erroneous standard was the correct standardof review. City of Belvidere, 181 Ill. 2d at 205.

In this case, unlike City of Belvidere, the parties stipulated to the facts and have not askedus to review any factual findings. On appeal plaintiff challenges the constitutionality of apportioningall its interest income from these accounts. Thus, the only issue before us involves a question of law,namely, whether the United States Constitution prohibits the Department from apportioning interestincome that plaintiff had available as working capital, but did not use as working capital. It is wellsettled that an administrative agency has no authority to declare a statute unconstitutional or evento question its validity. Texaco-Cities Service Pipeline Co. v. McGaw, 182 Ill. 2d 262, 278 (1998). Questions of law decided by an agency are not entitled to deference and are reviewed de novo. XLDisposal Corp. v. Zehnder, 304 Ill. App. 3d 202 (1999). The de novo standard of review applies tothe constitutional issue of law raised by Home Interiors.

The issue is whether all the interest income from plaintiff's short-term investmentsconstituted apportionable business income subject to Illinois tax. The United State Constitutionrequires that the taxpayer have "some minimum connection" with the taxing body and that the taxis "rationally related to 'values connected with the taxing [s]tate.' " Quill Corp. v. North Dakota, 504U.S. 298, 306, 119 L. Ed. 2d 91, 102, 112 S. Ct. 1904, 1909-10 (1992), quoting MoormanManufacturing Co. v. G.D. Bair, 437 U.S. 267, 273, 57 L. Ed. 2d 197, 204, 98 S. Ct. 2340, 2344(1978). Thus, a state may not tax value outside its borders. Allied-Signal, Inc. v. Director, Divisionof Taxation, 504 U.S. 768, 119 L. Ed. 2d 533, 112 S. Ct. 2251 (1992). The due process andcommerce clauses of the United States Constitution require " 'some definite link, some minimumconnection between a state and the *** transaction it seeks to tax.' " Quill Corp., 504 U.S. at 306,119 L. Ed. 2d at 102, 112 S. Ct. at 1909, quoting Miller Brothers Co. v. Maryland, 347 U.S. 340,344-45, 98 L. Ed. 744, 748, 74 S. Ct. 535, 539 (1954). A state may, however, tax the multistateincome of a nondomiciliary corporation if a minimal connection exists between the corporation'sactivities and the taxing state and a rational relationship exists between "the income attributed to thetaxing State and the intrastate value of the corporate business." Allied-Signal, Inc., 504 U.S. at 772,119 L. Ed. 2d at 542, 112 S. Ct. at 2255.

To determine whether a state may apportion corporate income of a nondomiciliarycorporation, the United State Supreme Court has applied the "unitary relationship" and "operationalfunction" tests. Under the unitary relationship test, the payee and the payor of the dividend or otherincome have a unitary business relationship. More specifically, although a business may havesubsidiaries, divisions, or common ownership of other businesses that operate in differentjurisdictions, a single state may tax all the income earned and apportion it because the businesseshave common managerial or operational resources that produce economies of scale and a substantialsharing of values. Container Corp. of America v. Franchise Tax Board, 463 U.S. 159, 179, 77 L.Ed. 2d 545, 562, 103 S. Ct. 2933, 2947 (1983). The Court has stated that " '[t]he linchpin ofapportionability in the field of state income taxation is the unitary-business principle.' " ASARCOInc. v. Idaho State Tax Comm'n, 458 U.S. 307, 317, 73 L. Ed. 2d 787, 795, 102 S. Ct. 3103, 3109(1982), quoting Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 439-40, 63 L. Ed. 2d 510,522, 100 S. Ct. 1223, 1232-33 (1980).

In this case, both parties agree that the unitary relationship test does not give the Departmentthe authority to tax all the interest income generated in the four short-term investment accounts. Plaintiff has no unitary relationship with the four banks that have paid plaintiff the interest on theshort-term investment accounts. The Department never sought to apportion the interest incomebased on a unitary relationship between Home Interiors and the holders of the general accounts. Each of these banks is a completely separate entity from plaintiff. The basis for the Department'sdetermination is that the general accounts are a working capital reserve fund and thus interest earnedby these accounts is also operational funds. Therefore, we must determine if the Department'sapportionment of all the income satisfies the operational function test.

Under the operational function test, a state may apportion income even though no unitaryrelationship exists between payee and payor. Allied-Signal, Inc., 504 U.S. at 787, 119 L. Ed. 2d at552, 112 S. Ct. at 2263. The state has the authority to apportion the income because the capitaltransaction serves an operational rather than an investment function. Allied-Signal, Inc., 504 U.S.at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263. The relevant inquiry in determining whether anasset serves an investment or operational function "focuses on the objective characteristics of theasset's use and its relation to the taxpayer and its activities within the taxing State." Allied-Signal,Inc., 504 U.S. at 785, 119 L. Ed. 2d at 550, 112 S. Ct. at 2262. The Court has noted that "a statemay include within the apportionable income of a nondomiciliary corporation the interest earned onshort-term deposits in a bank located in another State if that income forms part of the working capitalof the corporation's unitary business, notwithstanding the absence of a unitary relationship betweenthe corporation and the bank." Allied-Signal, Inc., 504 U.S. at 787-88, 119 L. Ed. 2d at 552, 112 S.Ct. at 2263. The Court concluded that the apportionability of interest turns on whether the interest"forms part of the working capital of the [taxpayer's] unitary business." Allied-Signal, Inc., 504 U.S.at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.

In Allied-Signal, Inc., the Court discussed a specific scenario addressed in ASARCO Inc. Inthat case, the Court found that Idaho could not apportion certain investment income that a subsidiaryof ASARCO earned because of a lack of a unitary relationship. Although the Court had notspecifically adopted the operational function test, the dissent referenced this test in concluding thatASARCO's subsidiary's investment income should be apportionable. The dissent relied on the operational nature of the source of the income. ASARCO Inc., 458 U.S. at 337-38, 73 L. Ed. 2d at808-09, 102 S. Ct. at 3120. (O'Connor, J., dissenting). According to the majority, the dissentcharacterized ASARCO's use of these investment funds as "interim uses of idle funds 'accumulatedfor the future operation of [ASARCO's] own primary business.' " ASARCO Inc., 458 U.S. at 324n.21, 73 L. Ed. 2d at 800 n.21, 102 S. Ct. at 3113 n.21. To rebut the dissent's claim that theinvestment in the stock served an operational function, the majority cited the trial court's factualfindings. The trial court specifically found that ASARCO never had been required to utilize its stockas security for any type of borrowing and that ASARCO had sufficient clash flow to run all of itsoperations without the need of any capital from this intangible income. ASARCO Inc., 458 U.S. at324 n.21, 73 L. Ed. 2d at 800 n.21, 102 S. Ct. at 3113 n.21. The Court in Allied-Signal, Inc. agreedwith the dissent's legal conclusion in ASARCO that if the stock investments in that case constituted" 'interim uses of idle funds' " accumulated for future operations, then they would have beenapportionable. Allied-Signal, Inc., 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263, quoting ASARCO Inc., 458 U.S. at 324 n.21, 73 L. Ed. 2d at 800 n.21, 102 S. Ct. at 3113 n.21. Thus, readingthese two cases together, we conclude that the corporation's use of the funds not the mere availabilityof the funds is the guiding factor in determining whether the income sought to be apportioned hasan operational or investment function.

In this case, the operational function test only permits the Department to tax a portion ofplaintiff's income from the short-term investment accounts, because only part of these funds has beenused as working capital. The majority of the funds within these accounts served an investmentfunction and did not form part of the working capital of plaintiff's business. Home Interior's fundsin its four investment accounts were far in excess of its working capital needs. In short, the recorddoes not establish an interim use of all these funds for an operational purpose. Like the investmentincome in ASARCO Inc., plaintiff did not use these funds for security on a loan or any other financialobligation and did not need these funds in order to operate its business. Home Interiors has nevertreated the entire balance in its four investment accounts as "operational" funds. Home Interiorsreported the entire balance of its four investment accounts on its financial statements as investments,and not as part of its working capital or operating assets. Home Interiors did not use its investmentsas collateral for any loans. When filing its Illinois corporate income tax returns and its Texasfranchise tax returns for the years at issue, Home Interiors consistently reported the interest incomefrom its four investments as investment income. In fact, Home Interiors reported all of the interestat issue as allocable to Texas (its commercial domicile) for purposes of calculating its Texasfranchise tax, and it reported and paid Texas franchise tax on the full amount of interest incomegenerated by its four investments.

The defendant has stipulated that "[d]uring the audit period, the funds from these generalaccounts, except the Salomon general account (see Exhibit E), were utilized in part as a workingcapital reserve. None of the funds in these general accounts were designated for a particular use, andall of the funds were available for use in the day to day business operations of the Taxpayer." (Emphasis added.) Significantly, in 1989, $87.9 million of Home Interiors' investments remainedintact and was not used for operational purposes. In 1990, $120.6 million of Home Interiors'investments remained intact and was not used for operational purposes. In each year, the investmentbalance remaining intact exceeded 60% of the highest end-of-month balance. Additionally, theinvestment balance remaining intact exceeded 75% of the average end-of-month balance in eachyear. Based on the foregoing facts, it is evident that Home Interiors did not use all of its funds inits four investments, and the interest income therefrom, for working capital purposes. Therefore,plaintiff has demonstrated that it has not used all of these funds for operational purposes and has metits burden to establish that only a portion of the income was apportionable.

The Department concedes that plaintiff did not use all the funds within the short-termaccounts for day-to-day operations but claims that, because the funds were idle and "available forday-to-day operations," the operational function test has been satisfied. The Department relies onplaintiff's failure to segregate these funds into separate operational and investment accounts. TheUnited States Supreme Court has rejected the claim that passive income somehow is transformedinto business income simply because the two types of income are commingled. F.W. Woolworth Co.v. Taxation & Revenue Department, 458 U.S. 354, 364 n.11, 73 L. Ed. 2d 819, 827 n.11, 102 S. Ct.3128, 3132 n.11 (1982) (investment income is not converted into apportionable business income byreason of being commingled with business income).

The Illinois Supreme Court has rejected an analogous commingling argument as a basis forfinding all income or property taxable. Streeterville Corp. v. Department of Revenue, 186 Ill. 2d534, 538 (1999). In that case, the Department sought to tax each space in a parking garage eventhough the garage allocated certain spaces to employees of a nonprofit hospital, thus subjecting thesespaces to a property tax exemption. The court rejected the Department's argument that a taxpayermust segregate its property between taxable and exempt use to claim a partial exemption and notedthat the Department had no difficulty in agreeing upon a percentage of the parking garage that wasexempt. Streeterville Corp., 186 Ill. 2d at 538-39.

We also find no significance in plaintiff's failure to segregate its investment and operationalfunds into separate accounts. The fact that plaintiff's available investment funds were not segregatedfrom the funds used for working capital needs does not render all the income generated within theshort-term accounts apportionable. Rather, in deciding whether funds in a short-term bank accountserve an operational or investment function, the Supreme Court's decisions in ASARCO Inc. andAllied-Signal, Inc. confirm that the court must determine how the corporation uses the funds. Seealso 1 J. Hellerstein & W. Hellerstein, State Taxation: Corporate Income and Franchise Taxes 9-91(2d ed. 1993) ("[I]f the payor is not a component of the unitary business and the asset is not used inthe conduct of the unitary business of which the recipient corporation is a part, the interest shouldbe allocable to the State of the taxpayer's domicile ***.") (Emphasis added.) It is the use of thefunds that establishes the minimal connection between the corporate's activities and the taxing state. Allied-Signal, Inc., 504 U.S. at 787, 119 L. Ed. 2d at 552, 112 S. Ct. at 2263.

Therefore, we further conclude that the mere availability of investment funds for day-to-dayoperations of a nondomiciliary corporation in a short-term account does not provide a sufficientconnection between the corporation's activities and the taxing state to allow the state to apportionthe interest income generated from these funds. If availability were the standard, all income froma taxpayer's short-term investment account would automatically serve an operational function simplybecause the funds were available for use. We reject this standard because it permits a state to taxincome that has no relationship to a taxpayer's activities in the taxing state.

The authority that the Department relies upon does not support its argument. In AlaskaDepartment of Revenue v. OSG Bulk Ships, Inc., 961 P.2d 399 (Alaska 1998), the Alaska SupremeCourt reversed a hearing officer's determination that investment income of the defendant, anondomiciliary corporation, was apportionable. The court found that the hearing officer improperlybased his decision on the defendant's commingling of investment and operational income, and thehearing officer applied an incorrect legal standard. The court ordered, on remand, that the hearingofficer segregate the income at issue between investment and operational functions. The courtfurther instructed that the defendant's investment income could only be apportioned if either "(1) theinvestment itself constitutes part of the corporation's unitary business ***, or (2) the investment isshort term and the income is used to fund the unitary business, such that the investment is analogousto a bank account for the unitary business." (Emphasis added.) OSG Bulk Ships, Inc., 961 P.2d at414.

In Port Affiliates, Inc. v. Wisconsin Department of Revenue, 190 Wis. 2d 272, 526 N.W.2d806 (1994), the taxpayer challenged Wisconsin's attempt to apportion income from its investmentportfolio of marketable securities. The taxpayer was incorporated in Wisconsin but had moved itsprincipal offices from Wisconsin to Florida. In rejecting the taxpayer's challenge, the courtdistinguished Allied-Signal, Inc. on the grounds that the taxpayer's corporation was incorporated anddomiciled in Wisconsin. Port Affiliates, Inc., 190 Wis. 2d at 286, 526 N.W.2d at 812. The courtfurther rejected the taxpayer's arguments that the accounts at issue were not used for operatingexpenses. The court cited a management agreement allowing for use of the funds for equipmentpurchases, actual use of the portfolio's funds for capital acquisitions, and an overall operationalefficiency as a result of the portfolio. Port Affiliates, Inc., 190 Wis. 2d at 285-88, 562 N.E.2d at 812-13.

Contrary to the Department's position, both OSG Bulk Ships, Inc. and Port Affiliates, Inc. support the conclusion that funds in a short-term investment account only have an operationalfunction if used in the corporation's operations. The court in OSG Bulk Ships, Inc. remanded thecase so that the hearing officer could determine if the funds in the short-term account were used inthe unitary business. Similarly, the court in Port Affiliates, Inc. pointed out several operational usesof the funds in the taxpayer's portfolio investment account. Therefore, neither case supports theDepartment's claim that the mere availability of funds in a corporation's short-term investmentaccount establishes an operational function for those funds and allows for an apportionment of anyand all earned income.

Here, the type of funds at issue was excess cash that was not used or part of plaintiff'sworking capital needs. The Department has stipulated to this fact. These funds served only aninvestment function. Home Interiors' passive investment income is not apportionable to Illinoissimply because Home Interiors used a small portion of its funds held for investment purposes for itsworking capital needs. Therefore, the operational function test does not give the Department theauthority to apportion all of the income from plaintiff's short-term investment accounts. Becauseneither the unitary relationship nor the operational function test has been satisfied, we conclude therelacks a sufficient nexus between these accounts and the State of Illinois for the Department toapportion all the interest that these accounts generated in 1989 and 1990. The apportionment of allthis income violates the commerce and due process clauses of the United States Constitution.

The Department, nevertheless, points out that plaintiff's formula to determine the percentageof income actually used for working capital needs and apportionable as business income is flawed. While it has always contended that no formula could actually segregate the type of funds within ageneral short-term account, it agreed to the exact amount of income it could apportion if plaintiffprevailed on its constitutional argument. The parties stipulated: "Should the Taxpayer prevail in itsposition that only the portion of the interest income that is available for use as working capital is tobe apportioned, the total amounts of income to be apportioned are as follows:

                                                                                      1989                             1990

Greatest % Invasion
into the Average Invest.                                                  24.90%                             14.98%

Income Amount used
in Business                                                                     $1,912,652.17          $1,650,448.80"

For the foregoing reasons, we reverse the decisions of the circuit court and the Departmentand remand for further proceedings consistent with this opinion.

Reversed and remanded.

TULLY and GALLAGHER, JJ., concur.