00-0993

Corporate Franchise Tax

Signed 3/26/03

 

                                     BEFORE THE UTAH STATE TAX COMMISSION

                                          ____________________________________

 

PETITIONER,                                                 )  FINDINGS OF FACT,

)  CONCLUSIONS OF LAW,

         Petitioner,                                                )  AND FINAL DECISION

) 

v.                                                                     )  Appeal No.      00-0993

)  Account No.    ######

AUDITING DIVISION OF                             ) 

THE UTAH STATE TAX                                )  Tax Type:        

COMMISSION,                                             )  Tax Year:         1996

)                         

Respondent.                                            )  Judge:               Davis

                                         _____________________________________

 

Presiding:                        

 G. Blaine Davis, Administrative Law Judge

 

Appearances:

For Petitioner:         PETITIONER REP A, ACCOUNTING FIRM

                              PETITIONER REP B, ACCOUNTING FIRM

For Respondent:     Mr. Clark Snelson, Assistant Attorney General

                              Mr. Kim Ferrell, from the Auditing Division

                              Ms. Valerie Newson, from the Auditing Division

 

 

                                                      STATEMENT OF THE CASE

This matter came before the Utah State Tax Commission for a Formal Hearing on February 7, 2002.  The parties requested time thereafter in which to file briefs, and the Administrative Law Judge later requested that the parties’ representatives answer certain questions.  Responses to those questions were received through the end of August 2002.  Based upon the evidence and testimony presented at the hearing, the Tax Commission hereby makes its findings of fact, conclusions of law and final decision.

                                                            MOTION TO STRIKE

At the Formal Hearing, Petitioner did not present any sworn testimony or affidavits and the discovery was not answered under oath.  In its "Statement of Position", the representative of Petitioner has made representations of what are purported to be the relevant facts.  Because of questions relating to the facts represented in the "Statement of Position" presented by the representative of Petitioner, Respondent has filed a Motion to Strike.  While the parties disagree on some of the facts, the Commission believes the facts necessary for its decision are substantially undisputed.  Except for the facts set forth in these Findings of Fact, the Motion to Strike is granted as to the facts alleged in the "Statement of Position" filed by Petitioner for the reasons set forth in the Motion.

FINDINGS OF FACT

1.  The tax in question is corporate franchise tax.

2.  The year in question is 1996.

3.  Petitioner, COMPANY A (“A”), is an “S” Corporation organized and incorporated in STATE in 1988.  None of the shareholders of Petitioner reside within the State of Utah.  OWNER A was reported on the 1996 return as owning 80% of Petitioner and OWNER B was reported as owning 20% of Petitioner. 

4.  Petitioner does not have any employees, either within or outside of the State of Utah.  The only assets of Petitioner, in 1996, were a vacation home in CITY, Utah, and a general partnership interest in COMPANY B, L.P. (“B”).  While Petitioner was the general partner in COMPANY B, there were numerous limited partners who invested in COMPANY B, thereby providing the funds for the investments of COMPANY B.

5.  From 1988 through 1996, COMPANY B purchased or developed numerous radio and television stations in various markets throughout the United States.  As of 1996, COMPANY B owned and operated ## radio and television stations in markets throughout the United States.  None of those radio or television stations were located within the State of Utah.

6.  Based on the operation of the radio stations, COMPANY B had positive cash flows and positive earnings for financial statement purposes, but because of the allowance of accelerated depreciation for income tax purposes, COMPANY B showed a net operating loss on its income tax returns.  In accordance with general principles of partnership taxation, these net operating losses were passed from COMPANY B to Petitioner and the other limited partners.

7.  Petitioner, because all its shareholders were non-residents, filed a return on behalf of its shareholders pursuant to Utah Code Ann. §59-7-703.  

8.  Because of OWNER A’s limited investments in Petitioner, it appears that he was unable to deduct all of his share of those net operating losses on his income tax returns.  Therefore, OWNER A transferred a vacation home in CITY, Utah, to Petitioner.  Based upon the transfer of the CITY home, OWNER A was apparently advised he could legally deduct, for income tax purposes, additional net operating losses passed through from COMPANY B.

9.  On the state income tax returns, those losses were apportioned among the states, including Utah, in which Petitioner and COMPANY B operated.  The net book value of the CITY home was included in the denominator of the fraction used to apportion Petitioner’s losses among the states.

10.  From 1993 to 1996, the vacation home in CITY was sometimes rented and was sometimes used by the family, friends, and business associates of OWNER A.  It appears that those business associates were entertained, at least in part, to further the interests of Petitioner.

11.  During 1996, the property was rented for approximately 24 days, and used for personal purposes by OWNER A, his friends and family for approximately 25 days.  The rental income for the days the home was rented was included as income on the tax return, and the expenses for the operation of the home were deducted on the tax returns up to the extent of the rental income.

12.  Section 280A of the Internal Revenue Code provides that if a vacation property is used for personal use for more than 14 days during the year, the deduction of expenses is limited to the amount of the rental income.  Accordingly, no net operating losses from the home were deducted on the income tax return of Petitioner, but the rental income was shielded from income taxes.

 13.  In 1996, COMPANY B entered into an agreement to sell its entire business, i.e., all of its radio and television stations, to COMPANY C for a substantial gain. COMPANY B reported its share of the gain on its 1996 Limited Partnership Tax Return, and that gain was passed through to Petitioner as the general partner, and to the other limited partner investors of COMPANY B.

14.  Petitioner treated the gain on the sale of the assets of COMPANY B as non-business income and, accordingly, allocated that gain to its commercial domicile.  Because neither the commercial domicile of COMPANY B or Petitioner, nor any of the radio or television stations, was located in Utah, none of the gain received by Petitioner or COMPANY B was allocated to Utah.

15.  Respondent audited Petitioner’s return and determined that the gain on the sale of the radio and television stations ultimately received by Petitioner from COMPANY B was business income, and that a portion thereof was taxable within the State of Utah.

16.  Petitioner filed a timely Petition for Redetermination, which ultimately resulted in the hearing hereon being held.

17.  The Commission also finds as facts those items set forth hereafter in the Discussion portion of this Decision.

                                                              APPLICABLE LAW

Utah Code Ann. §59-7-302 provides in relevant part:

(1) “Business income” means income arising from transactions and activity in the regular course of the taxpayer’s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitutes integral parts of the taxpayer’s regular trade or business operations.

(2) “Commercial domicile” means the principal place from which the trade or business of the taxpayer is directed or managed.

. . . .

(4) “Nonbusiness income” means all income other than business income.

 

Utah Code Ann. §59-7-303 provides for apportionable income as follows:

(1) Any taxpayer having income from business activity which is taxable both within and without this state shall allocate and apportion its adjusted income as provided in this part.

(2) Any taxpayer having income solely from business activity taxable within this state shall allocate or apportion its entire adjusted income to this state.

 

Utah Code Ann. §59-7-305 provides:

For purposes of allocation and apportionment of income under this part, a taxpayer is taxable in another state if:

(1) in that state the taxpayer is subject to a net income tax, a franchise tax measured by net income, a franchise tax for the privilege of doing business, or a corporate stock tax; or

(2) that state has jurisdiction to subject the taxpayer to a net income tax regardless of whether, in fact, the state does or does not.

 

Utah Code Ann. §59-7-306 provides for the allocation of non-business income as follows:

Rents and royalties from real or tangible personal property, capital gains, interest, dividends, or patent or copyright royalties, to the extent that they constitute nonbusiness income, shall be allocated as provided in Sections 59-7-307 through 59-7-310.

 

Utah Code Ann. §59-7-307 provides for the allocation of rents and royalties as follows:

(1) To the extent that the following constitute nonbusiness income:

(a) net rents and royalties from real property located in this state are allocable to this state; and

(b) net rents and royalties from tangible personal property are allocable to this state:

(i) if and to the extent that the property is utilized in this state; or 

(ii) in their entirety if the taxpayer’s commercial domicile is in this state and the taxpayer is not organized under the laws of or taxable in the state in which the property is utilized.

(2) The extent of utilization of tangible personal property in a state is determined by multiplying the rents and royalties by a fraction, the numerator of which is the number of days of physical location of the property in the state during the rental or royalty period in the taxable year and the denominator of which is the number of days of physical location of the property everywhere during all rental or royalty periods in the taxable year.  If the physical location of the property during the rental or royalty period is unknown or unascertainable by the taxpayer, tangible personal property is utilized in the state in which the property was located at the time the rental or royalty payer obtained possession.

 

Utah Code Ann. §59-7-308 provides for the allocation of capital gains and losses as follows:

To the extent that the following constitute nonbusiness income:

(1) capital gains and losses from sales of real property located in this state are allocable to this state;

(2) capital gains and losses from sales of tangible personal property are allocable to this state, if:

(a) the property had a situs in this state at the time of the sale; or

(b) the taxpayer’s commercial domicile is in this state and the taxpayer is not taxable in the state in which the property had a situs; and

(3) capital gains and losses from sales of intangible personal property are allocable to this state if the taxpayer’s commercial domicile is in this state.

 

Utah Code Ann. §59-7-309 provides for the allocation of interest and dividends as follows:

To the extent they constitute nonbusiness income, interest and dividends are allocable to this state if the taxpayer’s commercial domicile is in this state.

 

Utah Code Ann. §59-7-310 provides for the allocation of patent and copyright royalties as follows:

(1) To the extent they constitute nonbusiness income, patent and copyright royalties are allocable to this state:

(a) if and to the extent that the patent or copyright is utilized by the payer in this state; or

(b) if and to the extent that the patent or copyright is utilized by the payer in a state in which the taxpayer is not taxable and the taxpayer’s commercial domicile is in this state.

(2) A patent is utilized in a state to the extent that it is employed in production, fabrication, manufacturing, or other processing in the state or to the extent that a patented product is produced in the state.  If the basis of receipts from patent royalties does not permit allocation to states or if the accounting procedures do not reflect states of utilization, the patent is utilized in the state in which the taxpayer’s commercial domicile is located.

(3) A copyright is utilized in a state to the extent that printing or other publication originates in the state.  If the basis of receipts from copyright royalties does not permit allocation to states or if the accounting procedures do not reflect states of utilization, the copyright is utilized in the state in which the taxpayer’s commercial domicile is located.

 

Utah Code Ann. §59-7-311 provides for the apportionment of business income as follows:

All business income shall be apportioned to this state by multiplying the income by a fraction, the numerator of which is the property factor plus the payroll factor plus the sales factor, and the denominator of which is three.

 

Utah Code Ann. § 59-7-320 provides for the equitable adjustment of the standard allocation or apportionment as follows:

If the allocation and apportionment provisions of this chapter do not fairly represent the extent of the taxpayer’s business activity in this state, the taxpayer may petition for or the commission may require, in respect to all or any part of the taxpayer’s business activity, if reasonable:

(1) separate accounting;

(2) the exclusion of any one or more of the factors;

(3) the inclusion of one or more additional factors which will fairly represent the taxpayer’s business activity in this state; or

(4) the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income.

 

Utah Code Ann. §59-7-117 provides for other equitable adjustments as follows:

The commission shall by rule prescribe for adjustments to Utah taxable income when, solely by reason of the enactment of this chapter, a taxpayer would otherwise receive or have received a double tax benefit or suffer or have suffered a double tax detriment.  However, the commission may not make any adjustment pursuant to this section which will result in an increase or decrease of tax liability that is less than $25.

 

Utah Administrative Code Rule R865-6F-8 provides rules to interpret the statutes, and in relevant part provides:

A. Business and Nonbusiness Income Defined.  Section 59-7-302 defines business income as income arising from transactions and activity in the regular course of the taxpayer’s trade or business operations.  In essence, all income that arises from the conduct of trade or business operations of a taxpayer is business income.  For purposes of administration of the Uniform Division of Income for Tax Purposes Act (UDITPA), the income of the taxpayer is business income unless clearly classifiable as nonbusiness income.

1.  Nonbusiness income means all income other than business income and shall be narrowly construed.

2.  The classification of income by the labels occasionally used, such as manufacturing income, compensation for services, sales income, interest, dividends, rents, royalties, gains, operating income, and nonoperating income, is of no aid in determining whether income is business or nonbusiness income.  Income of any type or class and from any source is business income if it arises from transactions and activity occurring in the regular course of a trade or business.  Accordingly, the critical element in determining whether income is business income or nonbusiness income is the identification of the transactions and activity that are the elements of a particular trade or business.  In general, all transactions and activities of the taxpayer that are dependent upon or contribute to the operation of the taxpayer’s economic enterprise as a whole constitute the taxpayer’s trade or business and will be transactions and activity arising in the regular course of business, and will constitute integral parts of a trade or business.

3. Business and Nonbusiness Income.  Application of Definitions.  The following are rules for determining whether particular income is business or nonbusiness income:

a) Rents from real and tangible personal property.  Rental income from real and tangible property is business income if the property with respect to which the rental income was received is used in the taxpayer’s trade or business or is incidental thereto and therefore is includable in the property factor under G.1.a).

b) Gains or Losses from Sales of Assets.  Gain or loss from the sale, exchange or other disposition of real or tangible or intangible personal property constitutes business income if the property while owned by the taxpayer was used in the taxpayer’s trade or business.  However, if the property was utilized for the production of nonbusiness income the gain or loss will constitute nonbusiness income. See G.1.b).

. . . .

B.  Definitions.

1. “Taxpayer,” for purposes of this rule, is as defined in Section 59-7-101.

2. “Apportionment” means the division of business income between states by the use of a formula containing apportionment factors.

3. “Allocation” means the assignment of nonbusiness income to a particular state.

4. “Business activity” refers to the transactions and activity occurring in the regular course of the trade or business of a taxpayer.

C. Apportionment.

1. If the business activity with respect to the trade or business of a taxpayer occurs both within and without this state, and if by reason of that business activity the taxpayer is taxable in another state, the portion of the net income (or net loss) arising from the trade or business derived from sources within this state shall be determined by apportionment in accordance with Sections 59-7-311 to 59-7-319.

2.  Allocation.  Any taxpayer subject to the taxing jurisdiction of this state shall allocate all of its nonbusiness income or loss within or without this state in accordance with Sections 59-7-306 to 59-7-310.

 

                                                                  DISCUSSION

Utah has adopted certain allocation and apportionment provisions, commonly referred to as the Uniform Division of Income for Tax Purposes Act (UDITPA), to determine what portion of the income from a multistate business is properly subject to Utah tax.  These provisions are contained beginning at Utah Code §59-7-302 and going through §59-3-321. 

To use the UDITPA formula, the income of the corporation must first be divided into two separate categories, i.e., business income and nonbusiness income.  Business income is apportioned to each state through the use of a formula based upon the property, sales, and payroll of the taxpayer occurring in each state.  (Utah Code Ann. §59-7-311).  On the other hand, nonbusiness income is generally allocated to the state in which the taxpayer is domiciled.

Utah Code Ann. §59-7-302 defines business income and nonbusiness income as follows:

(1) “Business income” means income arising from transactions and activity in the regular course of the taxpayer’s trade or business and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitutes integral parts of the taxpayer’s regular trade or business operations.

. . . .

(4) “Nonbusiness income” means all income other than business income.

 

Therefore, the tax treatment of corporate income depends upon its classification as either business income or nonbusiness income.  Because nonbusiness income is all income other than business income, a determination must be made whether income is "business income".

In construing the above definition, almost all courts agree that the first clause in the definition establishes a transactional test, but numerous courts have construed the second clause as a separate functional test for business income.  Uniroyal Tire Company v. Dept of Finance (Ala. 2000) 779 SO. 2d 227, 230.  Under that construction, corporate income is business income if it meets either the transactional test or the functional test.  However, some other courts have rejected that approach and have interpreted the two clauses as a single transactional test.  Nevertheless, this Commission has previously held that income may be business income if it meets either the transactional test or the functional test.

The functional test is embodied in Rule R865-6F-8.A.3.b, which provides as follows:

"Gains or losses from Sales of Assets.  Gain or loss from the sale, exchange or other disposition of real or tangible or intangible personal property constitutes business income if the property while owned by the taxpayer was used in the taxpayer’s trade or business.  However, if the property was utilized for the production of nonbusiness income the gain or loss will constitute nonbusiness income."

 

Although very few facts were actually presented in this case, the representative of Petitioner has characterized the business of Petitioner as follows:

"Petitioner was in the business of providing television and radio communication services through the ownership of a general partnership interest in COMPANY B, L.P. ("COMPANY B").  Petitioner was not in the business of trading or buying and selling broadcast stations, as Petitioner did not have a direct ownership interest in any broadcast stations.  Additionally, COMPANY B was not in the business of buying or selling broadcast stations, as prior to the one-time sale of all of B's assets, COMPANY B operated for approximately eight years and had not disposed of any of its television and radio stations."

 

Respondent, on the other hand, characterizes the business of Petitioner as follows:

"COMPANY A’ activity consisted merely of holding a general partnership interest in managing the business of a limited partnership."  This representation made by Petitioner in its response to Interrogatories No. 21, was repeated in correspondence from Petitioner dated September 4, 2001 and January 25, 2002.  This is a clear statement by Petitioner of the scope of its business.  In its arguments, Petitioner blurs an important distinction between the business of COMPANY A, which is holding the investment in the partnership interest, and the business of COMPANY B. COMPANY A was formed as an investment vehicle to hold a 12.723% general partnership interest in B."

 

In this matter, the Commission determines that Petitioner has more accurately stated its business for purposes of these statutes.  Utah Code Ann. Section 59-10-302(1) provides as follows:

Each item of partnership income, gain, loss, or deduction has the same character for a partner under this chapter as it has for federal income tax purposes.  When an item is not characterized for federal income tax purposes, it has the same character for a partner as if realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership.

 

Whether gain from the sale of these assets is business or nonbusiness income is not relevant for federal tax purposes.  Accordingly, the gain is "an item [that] is not characterized for federal income tax purposes [and] has the same character for [Petitioner] as if realized directly . . . ."  In other words, the state tax treatment of this gain is just as if Petitioner had owned and sold the radio stations itself.[1]                             The Commission also finds and determines that the home in Utah was used to further COMPANY B’s business.  It appears that many of the persons who were invited to enjoy those facilities included investment bankers, brokers, and other persons who would be useful to Petitioner in raising money or capital to finance the business of both Petitioner and COMPANY B.  Petitioner, in prior years, included the home in its business apportionment factors.  In the words of Utah Administrative Code, Rule R865-6F-8.A.2, the Park City home contributed "to the operation of the taxpayer’s economic enterprise as a whole. . . . .”

Based upon those determinations, Petitioner’s portion of the income from the sale of the assets of COMPANY B is apportionable as business income if the income was generated from transactions arising in the regular course of COMPANY B’s trade or business (the transactional test) or if the assets sold were integral parts of COMPANY B’s regular trade or business operations (the functional test). 

The Transactional Test

Pursuant to the transactional test, corporate income is business income if it arises "from transactions and activity in the regular course of the taxpayer’s trade or business. "  (Utah Code Ann. §59-7-302).  This test was discussed in a recent case from the Supreme Court of California, Hoecht Celanese Corp. v. Franchise Tax Board (2001) 25 Cal. 4th 508 at 520, 22 P.3d 324, 2001 Cal. LEXIS 3088, 106 Cal. Rptr 2d 548.  The California Supreme Court said:

The language of the transactional test is unambiguous, and courts have construed this language in a consistent manner.  "The controlling factor by which" the transactional test "identifies business income is the nature of the particular transaction" that generates the income.  (Western Natural Gas, supra, 446 P.2d at p. 783.)  To create business income, these "transactions and activity" must occur "in the regular course of the taxpayer’s trade or business." . . . .  "[R]elevant considerations include the frequency and regularity of similar transactions, the former practices of the business, and the taxpayer’s subsequent use of the income."  (Phillips Petroleum, supra, 511 N.W.2d at pp. 610-611.)  Thus, income arising from "extraordinary" events such as a "complete liquidation and cessation of business" cannot satisfy the transactional test.  (Uniroyal Tire Co., supra, 779 So.2d at p. 236.)

 

Petitioner’s “Statement of Position” alleges that the sale of the radio stations was such an “extraordinary” event.  This statement is unsupported by admissible evidence and, as noted, we have partially granted Respondent’s motion to strike.  Thus, Petitioner has not carried its burden of proof on this issue.  In any event, however, it is unnecessary for the Commission to determine whether the income in question meets the transactional test, because the income clearly is business income under the functional test, as outlined below.

The Functional Test

Pursuant to the functional test, corporation income is business income "if the acquisition, management, and disposition of the property constitutes integral parts of the taxpayer’s regular trade or business operations."   The California Supreme Court in the Hoechst Celanese case, supra, presented an excellent analysis of the functional test as follows:

 

We begin our analysis by examining the statutory language.  In contrast to the transactional test, which focuses on the income-producing "transactions and activity, " the functional test, . . . focuses on the income-producing property. "  . . . . This property may be "tangible" or "intangible" (ibid.), and the nature of the relationship between this property and the taxpayer’s "business operations" is the critical inquiry (Texaco-Cities, supra, 695 N.E.2d at p. 486 [the functional test "focuses upon the role or function of the property as being integral to regular business operations"]).

. . . .

 

We reject Hoechst’s contention that the word "regular" limits the functional test to normal or customary corporate events.  Although "regular" has the same meaning in the transactional and functional tests, it is not used in the same way in these tests.  In the transactional test--which focuses on the income-producing transaction--"regular" modifies "course of the taxpayer’s trade or business" and makes the nature of the transaction relevant.  (Associated Partnership I, supra, 889 S.W.2d at p. 195.)  In the functional test—which focuses on the income producing property--"regular" modifies "trade or business operations" and follows the phrase "an integral part of."  Consequently, "regular, " as used in the functional test, does not refer to the nature of the transaction, and the extraordinary nature or infrequency of the income-producing transaction is irrelevant.  (See Citicorp of North America, Inc. v. Franchise Tax Bd. (2000) 83 Cal.App.4th 1403, 1430 Citicorp); see also Pierce Associates, supra, 462 A2d S.E.2d at p. 1131; Texaco-Cities, supra, 695 N.E.2d at p. 484; Polaroid, supra, 507 S.E.2d at p. 289; Ross-Araco, supra, 674 A.2d at p. 693.)

 

Thus, the phrase "regular trade or business operations" . . . . establishes that the taxpayer’s control and use of the income-producing property must be part of the taxpayer’s normal or typical business activities.  The statutory term "integral" then provides the touchstone for determining whether the property has a close enough relationship to the taxpayer to satisfy the functional test.  (Ibid.) 

. . . .

 

As, noted above, the functional test is embodied in Utah State Tax Commission Rule R865-6F-8.A.3.b, which provides:

"Gains or losses from Sales of Assets.  Gain or loss from the sale, exchange or other disposition of real or tangible or intangible personal property constitutes business income if the property while owned by the taxpayer was used in the taxpayer’s trade or business.  However, if the property was utilized for the production of nonbusiness income the gain or loss will constitute nonbusiness income."

 

                        It is not disputed that the assets of the radio stations, whose gain is in question, were used in COMPANY B’s business.  Accordingly, the Commission finds that the gain from the sale of property of those assets is business income, both for COMPANY B and its general partner, OWNER A.  The CITY home, used as a place for bankers, brokers, and other persons who could assist in raising capital for Petitioner, made a material contribution to Petitioner's business.  The CITY home and the investment in COMPANY B were, therefore, part of the same unitary business.  As stated in Rule R865-6F-8.A.2:  “all transactions and activities of the taxpayer that are dependent upon or contribute to the operation of the taxpayer’s economic enterprise as a whole constitute the taxpayer’s trade or business. . . .”

An additional argument of Petitioner is that the income at issue should be deemed to be nonbusiness income because Petitioner disposed of its entire business and the assets were distributed to its shareholders rather than being reinvested in the business.  Petitioner cites as authority for that position Blessing/White, Inc. v. Zehnder, No. 99L 51087 (Ill. Cire. Ct. Cook Cty. Jan 24, 2001), Laurel Pipe Line Co. v. Commonwealth, 537 Pa. 205 (1994), Lenox, Inc. v. Offerman, No. COA99-1267 (N.C. Ct.App., Dec 5, 2000), McVean & Barlow, Inc. v. New Mexico Bureau of Revenue, 543 P.2d 489 (N.M. Ct.App. 1975), Welded Tube Co. v. Commonwealth, 515 A.2d 988 (Pa. Commw. Ct. 1986), and Texaco-Cities Service Pipeline Co. v. McGaw, 695 N.E. 2d 481 (Ill. 1998).

The substance of those decisions was that a liquidation of all or part of a business operation followed by a distribution of the proceeds to the shareholders is an extraordinary transaction which is not in the furtherance of the business of the company.  While that logic is understandable if the transactional test is being applied, the Commission believes it is not correct to apply that logic to the functional test.  That test is more correctly stated by the Commission's Rule R865-6F-8.A.3.b when it says, "Gain or loss from the sale, exchange or other disposition of real or tangible or other intangible personal property constitutes business income if the property while owned by the taxpayer was used in the taxpayer's trade or business."  This Rule embodies the logical conclusion that property which was depreciated or amortized as business property and was used by the taxpayer to apportion income among the various states while it was owned by the taxpayer, should be deemed to produce business income when it is sold.

This view is also consistent with the decisions of the California State Board of Equalization.  In Appeal of Jim Beam Brands and Co., State Bd. of Equal., No. 89002468010, 3/29/01, the Board found that income from the partial liquidation of a business was business income, regardless of whether the income was derived from an occasional or extraordinary transaction.  The Board based its decision in part on a prior decision in Appeal of Borden, Inc., 77-SBE-007 (Cal. St. Bd. Equal., Feb 3, 1977), where it was determined that the gain from the disposition of property is business income if the property was used in the taxpayer's trade or business during the period the taxpayer owned the property.  That ruling is consistent with the rule (R865-6F-8.A.3.b) adopted by the Commission.  The Board in that case also rejected the argument that a partial liquidation is an exception to the functional test, and determined that the sale of a division of a business produces business income unless the division had not been part of the taxpayer's unitary business.  This Commission determines that case represents a correct interpretation of the law.

In Hoechst Celanese Corporation v. Franchise Tax Board, Supra, the California Supreme Court, after a thorough analysis, stated:

"Forming these interpretations of the statutory language into a cohesive whole, we conclude that income is business income under the functional test if the taxpayer's acquisition, control and use of the property contribute materially to the taxpayer's production of business income.  In making this contribution, the income-producing property becomes interwoven into and inseparable from the taxpayer's business operations.  Such an interpretation of the functional test flows from the ordinary meaning of the statutory language and the California decisions that formed the basis for the UDITPA definition of "business income."

 

Based upon the foregoing, the Commission determines that the acquisition, control and use of the television and radio stations contributed materially to the taxpayer's production of business income or loss.  Therefore, the income of Petitioner from the sale and distribution of assets by COMPANY B constituted business income, which is apportionable to the states in which Petitioner did business, and such apportionment should occur pursuant to the UDITPA formula.

Modification of the Apportionment Formula

In its "Statement of Position," Petitioner argues:

Even if the Commission determines that the gain reported on the Petitioner's 1996 Utah Corporation Franchise Tax Return should be apportioned under Utah Code Ann. §59-7-311 rather than allocated under Utah Code Ann. §59-7-306 and §59-7-308, the relief provisions under Utah Code Ann. §59-7-117 or §59-7-320 should apply.

 

Utah Code Ann. § 59-7-320 provides for the equitable adjustment of the standard allocation or apportionment as follows:

If the allocation and apportionment provisions of this chapter do not fairly represent the extent of the taxpayer’s business activity in this state, the taxpayer may petition for or the commission may require, in respect to all or any part of the taxpayer’s business activity, if reasonable:

(1) separate accounting;

(2) the exclusion of any one or more of the factors;

(3) the inclusion of one or more additional factors which will fairly represent the taxpayer’s business activity in this state; or

(4) the employment of any other method to effectuate an equitable allocation and apportionment of the taxpayer’s income.

 

Utah Code Ann. §59-7-117 provides for other equitable adjustments as follows:

The commission shall by rule prescribe for adjustments to Utah taxable income when, solely by reason of the enactment of this chapter, a taxpayer would otherwise receive or have received a double tax benefit or suffer or have suffered a double tax detriment.  However, the commission may not make any adjustment pursuant to this section which will result in an increase or decrease of tax liability that is less than $25.

 

In asking for relief from the regular UDITPA formula pursuant to U.C.A. §59-7-320, the representative of Petitioner has argued primarily that Respondent should allow separate accounting for the rental income on the CITY home.  However, that is not the way in which Petitioner has ever filed its tax returns, either when it would have shown a loss, or when it would have shown a profit.  Petitioner’s return indicates that 0% of its sales, 0% of its payroll and about 9% of its property were in Utah.  Accordingly, only about 3% of its income was apportioned to Utah.  Petitioner has not presented any evidence to prove that the apportionment provisions produce an unreasonable result.  Indeed, both Petitioner’s original and amended 1996 return reported losses to Utah from operations of COMPANY B based on that 3% apportionment factor.  No evidence was presented that that percentage does not “fairly represent the extent of taxpayer’s business activity in the state” pursuant to §59-7-320. 

In Deseret Pharmaceutical Company, Inc. v. State Tax Commission, 579 P.2d 1322 (Utah 1978), the Utah Supreme Court stated:

Professor Pierce, the draftman of the Uniform Act, clearly was of the opinion that the relief provisions should be interpreted narrowly and were designed to permit the use of methods different than those prescribed in the Act only in unusual cases and in cases where the application of the specifically prescribed methods might be held unconstitutional.  Shortly after the act was drafted he published an article discussing these provisions.  He states that "the Uniform Act, if adopted in every state having a net income tax or a tax measured by net income, would assure that 100 percent of income, and no more and no less, would be taxed."  Obviously this statement would not be true if the relief provisions were interpreted to give the administrators in the different states broad discretion in the selection of alternative methods.

 

Professor Pierce further indicates that the instances in which the prescribed methods may produce an unreasonable or unconstitutional result are apt to be rare.  He warns also that:

 

"departures from the basic formula should be avoided except where reasonableness requires.  Nonetheless, some alternative method must be available to handle the constitutional problem as well as the unusual cases, because no statutory pattern could ever resolve satisfactorily the problems for the multitude of taxpayers with individual business characteristics."

 

We hold that the party seeking to invoke the relief provisions of the act must prove that under the apportionment provisions of the act an unreasonable result will occur, such as, the taxes imposed are grossly disproportionate to the taxpayer's business activity in this state, or extraterritorial income is being taxed.  We believe such an interpretation will effectuate the general purpose of the act to make the law of the enacting states uniform . . . and to assure that 100 percent of income, no more or no less, will be taxed.  (Emphasis added.)

 

Under the holding of the Utah Supreme Court in Deseret Pharmaceutical, Petitioner had the burden to prove that "under the apportionment provisions of the act an unreasonable result will occur. . . ."  Petitioner did not meet that burden of proof, and therefore there is no basis for the Commission to order separate accounting under Utah Code Ann. §59-7-320.

With respect to the argument of Petitioner that equitable relief should be granted under Utah Code Ann. §59-7-711 because Petitioner has "suffered a double tax detriment", Petitioner has not presented any evidence that it has suffered a double tax detriment.  The value of the CITY home was included in both the numerator and the denominator of the apportionment formula, and it therefore appears there was no double tax detriment.

                                                         DECISION AND ORDER

Based upon the foregoing, the Tax Commission determines that the income of Petitioner received from the sale by COMPANY B of its assets and the distribution of a share of those profits to Petitioner in its investment business constitutes business income which is apportionable among the states in which Petitioner does business.  Also, Petitioner has not met its burden of proof to show that equitable relief is required under either Utah Code Ann. §59-7-320 or §59-7-117.  Accordingly, the audit assessment of Respondent is hereby sustained, and the Petition for Redetermination is denied.  It is so ordered.

DATED this   26th   day of   March  , 2003.

 

_________________________________

G. Blaine Davis

Administrative Law Judge

 

BY ORDER OF THE UTAH STATE TAX COMMISSION:

The Commission has reviewed this case and the undersigned concur in this decision.

DATED this   26th   day of   March  , 2003.

 

 

Pam Hendrickson                                                         R. Bruce Johnson

Commission Chair                                                        Commissioner

 

 

Palmer DePaulis                                                           Marc B. Johnson

Commissioner                                                               Commissioner  

 



[1] This conclusion is also consistent with R865-6F-8.J.5 which provides that a corporate partner shall use its pro rata share of the partnership’s property, payroll and sales factors in determining its own apportionment factors.