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State & Local Tax Bulletin (June 2002)

Is Cessation of a Business
Every State's Business or ... ?




By Jeffrey M. Vesely, a tax partner in the San Francisco office of Pillsbury Winthrop Shaw Pittman LLP. If you have or can obtain the Acrobat Reader, or have an Acrobat-enabled web browser, you may wish to download or view our June 2002 State & Local Tax Bulletin (a 519K pdf file), containing a printed version of this article and also available via ftp at ftp.pmstax.com/state/bull0206.pdf.

Mr. Vesely presented this paper as part of the Georgetown University Law Center 25th Annual Advanced State & Local Tax Institute on May 16-17, 2002.

This bulletin concerning state and local tax matters is part of the Tax Page, a World Wide Web demonstration project, no portion of which is intended and cannot be construed as legal or tax advice. Comments are welcome on the design or content of this material.


  1. Introduction

    The issue of the characterization of income as either business or nonbusiness income continues to be one of the most contentious in state and local taxation. Notwithstanding the existence of the Uniform Division of Income for Tax Purposes Act (UDITPA) and its definitions of business and nonbusiness income, which have remained unchanged for over 40 years, there is little uniformity among the states as to what constitutes apportionable "business income" or allocable "nonbusiness income." This lack of uniformity is especially pronounced in the context of the disposition of business assets, including partial or complete liquidations. This bulletin focuses on the classification of income from the disposition of business assets and examines recent judicial and legislative trends.

  2. Business and Nonbusiness Income under UDITPA

    1. UDITPA Definitions

      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 or intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations." UDITPA § 1(a)

      2. "Nonbusiness income means all income other than business income." UDITPA § 1(e)

    2. Multistate Tax Commission Regulations

      1. "[A]ll income which arises from the conduct of trade or business operations of a taxpayer is business income ... [T]he income of the taxpayer is business income unless clearly classifiable as nonbusiness income." MTC Reg. IV.1.(a)

      2. "Gain or loss from the sale, exchange or other disposition of real property or of 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 or otherwise removed from the property factor before its sale, exchange or other disposition, the gain or loss will constitute nonbusiness income." MTC Reg. IV.1.(c).(2)

      3. The MTC has proposed amending its regulations pertaining to the definition and classification of business income. (November 2001 Proposal #2). The first public hearing was held on April 15, 2002. The second public hearing was held on April 29, 2002. The proposed regulations may come before the MTC for a vote as early as July.

        1. The proposed regulations continue to employ both the transactional and functional tests and expand upon the definitions and descriptions of the two tests.

        2. Key terms such as "trade or business," "to contribute materially," "property," "acquisition," "management," "disposition" and "integral part" are defined.

        3. The proposed regulations specifically provide that "income that is derived from isolated sales, leases, assignments, licenses, and other infrequently occurring dispositions, transfers, or transactions involving property, including transactions made in liquidation or the winding-up of business, is business income, if the property is or was used in the taxpayer's trade or business operations." See MTC Proposed Reg. IV.1.(a).(5).(B).

        4. At the April 15, 2002 public hearing, a question was raised by a hearing participant whether the proposed regulations would treat income generated by a company that liquidates its assets in order to distribute the proceeds to its shareholders as business income. Paul Mines, the MTC Hearing Officer, responded that "the jury is still out on that one. It's an issue that continues to fester and the dust has not settled as to whether there is a liquidation exception in recognition of business income."

    3. Transactional and Functional Tests of Business Income Under UDITPA

      Courts are divided whether there are one or two tests for business income. States that take the position that there are two tests hold that if either of the two tests is satisfied, the income will constitute business income.

      1. Transactional test

        1. The transactional test arises under the first clause of the statutory definition. Under the transactional test, the relevant inquiry is whether the transaction or activity that gave rise to the income arose in the regular course of the taxpayer's trade or business.

        2. The frequency and regularity of the transactions are important factors for determining whether the proceeds of a disposition of business assets constitute business income under the transactional approach.

          1. Atlantic Richfield Co. v. State, 601 P. 2d 628 (Colo. 1979)

            1. The forced sale of Sinclair stock for antitrust reasons generated business income. The court focused on the fact that during the 20 years prior to the sale, ARCO was involved in 15 purchases or mergers and 11 sales of companies or blocks of assets.

        3. Some courts have held that the taxpayer's subsequent use of the proceeds is also a relevant inquiry.

      2. Functional test

        1. The functional test arises under the second clause of the definition. Under this test, the relevant inquiry is whether the acquisition, management and disposition of the property are integral parts of the taxpayer's regular trade or business operations.

        2. The test focuses on whether the property was used in the taxpayer's trade or business.

        3. Under a straightforward application of the functional test, the extraordinary or infrequent nature of the transaction (the disposition of business assets) is irrelevant.

          1. See, e.g., Hoechst Celanese Corp. v. Franchise Tax Board, 25 Cal. 4th 508 (2001) (pension reversion held to be business income under functional test, notwithstanding the fact the reversion was an extraordinary occurrence.)

        4. Some states apply the language literally and take the position that the "disposition" of the business assets must itself be an integral part of the taxpayer's regular unitary business operations.

          1. See, e.g., Phillips Petroleum Company v. Iowa Department of Revenue and Finance, 511 N.W. 2d 608 (Iowa, 1993) (gain from sale of assets to thwart hostile takeover nonbusiness income under functional test because the disposition was irregular in both its scope and its nature–a once-in-a-corporate-lifetime occurrence).

          2. Similar conclusions have been reached by courts in Alabama, Tennessee, North Carolina, Illinois and Pennsylvania. See, e.g., Uniroyal Tire Company v. Department of Finance, 779 So. 2d 227 (Ala. 2000); General Care Corp. v. Olsen, 705 S.W. 2d 642 (Tenn. 1986); Lenox, Inc. v. Tolson, 548 S.E. 2d 513 (N.C. 2001); Blessing/White, Inc., et al. v. Zehnder, CCH Ill. Tax Rptr. ¶ 401-337 (2002); Laurel Pipe Line Co. v. Commonwealth, 642 A. 2d 472 (Pa. 1994).

        5. Some states' statutes deviate from the uniform definition of the functional test and require only that the acquisition, the management or the disposition of the property be an integral part of the taxpayer's regular trade or business operations.

          1. See, e.g., N.C. Gen. Stat. § 105-130.4(a)(1).

  3. Case Law Regarding Dispositions of Business Assets

    1. Historical Developments

      1. Kansas

        1. Western Natural Gas Co. v. McDonald, 446 P. 2d 781 (Kan. 1968)

          1. A Texas-based oil company owned several oil and gas leases in Kansas which it held for exploration and production and not for resale. The taxpayer never sold any of these leases for the 16 years prior to undergoing a complete liquidation in 1963. The taxpayer treated the gains from the sale of the leases as nonbusiness income.

          2. The Kansas Supreme Court agreed with the taxpayer and concluded that the sale was not made in the regular course of business operations when measured by the taxpayer's former practices.

          3. The court emphasized that a complete plan of liquidation was carried out and that the "sale contemplated cessation rather than operation of the business."

          4. The court applied a transactional approach, holding that the controlling factor in determining business income is the nature of the particular transaction giving rise to the income.

        2. In re Chief Industries, Inc., 875 P. 2d 278 (Kan. 1994)

          1. The Kansas Supreme Court reaffirmed Kansas' adherence to the transactional approach and rejected the State's attempt to apply a functional test or a broadly defined transactional test.

          2. The case involved a nondomiciliary corporation based in Nebraska which sold stock in its Kansas recreational vehicle production facility which was part of its unitary business.

          3. The sales occurred over a 2-year period and reduced the taxpayer's ownership from 100 percent to 38.3 percent.

          4. The proceeds were used for general business needs, such as retirement of debt, purchase of assets, employee payroll, maintenance, etc.

          5. The court held that the sale produced nonbusiness income under the narrowly-defined transactional test set forth in Western Natural Gas.

      2. New Mexico

        1. McVean & Barlow, Inc. v. Bureau of Revenue, 543 P. 2d 489 (NM, 1975)

          1. The taxpayer was in the business of laying two kinds of pipeline, "little-inch" and "big-inch" pipeline. Pursuant to a major reorganization, the corporation liquidated its big-inch pipeline business which was located in Texas and Nevada.

          2. Evidence was presented that the sale was an unusual transaction and that it changed the geographical environment of where the business operated.

          3. The New Mexico Court of Appeals concluded that the gains were nonbusiness income under both the transactional and functional tests.

          4. The court stated, however, that it is not the use of the property in the taxpayer's trade or business which is the controlling factor. Rather, the determining factor is the nature of the particular transaction giving rise to the income. To constitute business income, the transaction and activity must have been in the regular course of the taxpayer's business operations.

          5. The court relied on Western Natural Gas and found that the sale of the large diameter pipeline assets was a partial liquidation of the taxpayer's business.

          6. According to the court, the sale "contemplated a cessation" of the taxpayer's large diameter pipeline business. As such, its disposition was not an integral part of the taxpayer's regular business operations.

          7. The dissent drew a distinction between a partial and complete liquidation and conceded that a complete liquidation and a cessation of a business would not yield business income under the functional test. ("In the peculiar context of a liquidation, there is no business which the sale or property can benefit.") The dissent also took issue with the majority's conclusion that the "novelty" of the transaction has any bearing on the question of whether the transaction produced business income under the functional test.

      3. Tennessee

        1. General Care Corp. v. Olsen, 705 S.W. 2d 642 (Tenn. 1986)

          1. Gains from the sales of hospitals in four states in connection with a corporate liquidation was held to constitute nonbusiness income.

          2. Although the court found that the hospitals were an integral part of the taxpayer's regular trade or business, it held that their disposition was not. The court found significant that the sales were in complete liquidation and served to terminate regular business operations.

          3. The court followed Western Natural Gas and McVean.

          4. The court stated: "We find that the Commissioner's position that the 'disposition' of property need not be within the scope of the taxpayer's regular business operations in order to give rise to business income contrary to the plain language of the statute. The drafters' use of the conjunction 'and' clearly indicates that the disposition, as well as the acquisition and management of property must be an integral part of the taxpayer's regular trade or business operations in order to produce business earnings."

        2. Federated Stores Realty, Inc. v. Huddleston, 852 S.W. 2d 206 (Tenn. 1992), reh'g. den. (1993)

          1. Parent was in the business of operating retail department stores. The taxpayer, its subsidiary, was in the business of developing, leasing and managing regional shopping centers. The subsidiary owned, in whole or in part, 13 shopping centers. During 1983 to 1988, the subsidiary sold all 13 shopping centers and ceased all development and management activities. The subsidiary continued in existence.

          2. The court held that the gains were nonbusiness income under the transactional test adopted in General Care because the sales of shopping centers pursuant to the corporation's decision to discontinue the business of developing, leasing and managing shopping centers were not made in the regular course of business. The subsidiary's primary purpose was to provide business facilities for its parent company's anchor stores in each center.

          3. The court analogized the sale of the shopping centers to a partial liquidation.

          4. The court relied upon the fact that the proceeds were paid to the parent as a dividend and were not used to acquire new assets for the shopping center business.

        3. Union Carbide Corp. v. Huddleston, 854 S.W. 2d 87 (Tenn. 1993)

          1. The taxpayer underwent a corporate restructuring after the Bhopal, India plant disaster. It then became the target of a hostile takeover. To prevent the takeover, the taxpayer repurchased 56 percent of its stock in 1986. In order to pay its debt, it sold its corporate headquarters and completely liquidated seven lines of business. All proceeds were distributed to the shareholders. Previously, the taxpayer had sold business assets, but never of such a magnitude. Nor had the taxpayer ever completely liquidated a line of business.

          2. The court concluded the gains constituted nonbusiness income under the transactional test since the sales did not occur in the regular course of the taxpayer's business. The court relied upon the following facts:

            1. All of the sales proceeds were distributed to the shareholders.

            2. The taxpayer had never before completely liquidated a line of business.

            3. The Bhopal disaster and the ensuing hostile tender offer were unusual events.

            4. The 1986 divestiture was "vastly larger" in magnitude than all prior divestitures combined.

            5. The sales in 1986 involved profitable business lines whereas earlier sales had involved only unprofitable ones.

        4. Associated Partnership I, Inc. v. Huddleston, 889 S.W. 2d 190 (Tenn. 1994)

          1. The taxpayer (API) was the parent of APII. In 1986, APII and another corporation formed a limited partnership that operated a publishing business in Tennessee. In 1988, APII sold 50 percent of its partnership interest to a third party and merged into API in a complete liquidation. Pursuant to the liquidation, the proceeds from the sale passed to API. The classification of the gain from APII's sale of the partnership interest was at issue.

          2. The court concluded the gain was nonbusiness income under the transactional test, relying upon the following:

            1. APII's sole business was holding and managing the partnership interest at issue.

            2. The sale of the partnership interest was not a frequent and recurring transaction.

            3. The sale resulted in the termination of APII's corporate existence.

            4. APII did not use the sale proceeds in any ongoing trade or business.

          3. The court rejected the Commissioner's argument that in determining business or nonbusiness income, the activities of the consolidated group should be considered. The court held that it is only the taxpayer's trade or business that is relevant.

          4. The court noted that even if the activities of the related corporations had been considered, the gain would still be nonbusiness because the disposition of a profitable publishing business was not a transaction that occurred frequently or regularly; the sale was contrary to the former business practices and philosophy of the controlling corporation; and the controlling corporation did not use the proceeds from the sale in any of the ongoing businesses. The proceeds were used to repurchase some of the ultimate parent's publicly traded stock.

      4. Pennsylvania

        1. Welded Tube Co. of America v. Commonwealth, 515 A. 2d 988 (Pa. 1986)

          1. Taxpayer was in the business of manufacturing welded tube. It sold at a gain a Philadelphia manufacturing facility, machinery and equipment. The taxpayer used the proceeds to retire corporate debt and to pay for expansion of its business which it continued at its remaining manufacturing plant. The Commonwealth argued that the gain was nonbusiness income wholly allocable to Pennsylvania.

          2. The Commonwealth Court concluded that the gains constituted business income under the transactional test, notwithstanding the fact that the taxpayer was not in the business of buying and selling manufacturing plants. In fact, the taxpayer had only sold real property twice over its 30-year corporate history.

          3. The court adopted the view that even occasional transactions could arise in the regular course of the taxpayer's business.

          4. According to the court, such transactions did not have to arise in the course of the taxpayer's principal business to constitute business income. It makes no difference whether the income derives from the taxpayer's main business, its occasional business or a subordinate business.

          5. The court recognized that the statutory definition contains an alternative, independent functional test, under which the extraordinary nature of the transaction is irrelevant.

          6. The court held that the gain also satisfied the functional test.

          7. The court found that while the principal business of the taxpayer was the manufacture of welded tube, it was a regular practice of the taxpayer to acquire property in the expansion of its business. This property constituted an integral part of the taxpayer's business, and its disposition produced business income.

          8. The court relied upon the fact that the proceeds from the sale were reinvested in taxpayer's on-going business operations.

          9. The court noted that the disposition did not contemplate the cessation of any part of the taxpayer's regular business.

        2. Laurel Pipe Line Co. v. Board of Fin. and Revenue, 642 A. 2d 472 (Pa. 1994)

          1. Taxpayer was engaged in transporting refined petroleum products by pipeline from refinery connections between Philadelphia and Pittsburgh. The taxpayer also operated a pipeline between Aliquippa, Pennsylvania and Cleveland, Ohio. The taxpayer discontinued the operation of the Aliquippa-Cleveland pipeline in 1983. Three years later, it sold at a gain the pipeline and related assets. All sales proceeds were distributed to its shareholders.

          2. The court recognized that the statutory definition contains two tests for business income. The parties had conceded that the income did not satisfy the transactional test.

          3. The court held that the gain was nonbusiness income under the functional test, relying upon the following:

            1. Because the pipeline had been idle for over three years prior to its sale, the disposition was, in essence, a partial liquidation and not an integral part of the taxpayer's regular business operations.

            2. Taxpayer's distribution of the proceeds to the shareholders rather than the reinvesting of them in the business was further evidence of a liquidation of a separate and distinct aspect of its business.

      5. Illinois

        1. Texaco-Cities Service Pipeline Co. v. McGaw, 695 N.E. 2d 481 (Ill. 1998)

          1. Taxpayer was engaged in the business of transporting crude oil and other petroleum products. In 1983, the taxpayer sold 90 percent of the assets of its pipeline business, including all such assets in Illinois. The proceeds were reinvested back into the pipeline business.

          2. The Illinois Supreme Court concluded the gain from the sale of the pipeline assets was business income under the functional test.

          3. The court focused on the use of the pipelines in the taxpayer's business, and found that they had produced business income to the taxpayer.

          4. In addition, the court noted that the pipelines had been included in the property factor in the year of sale.

          5. The court distinguished Laurel Pipe Line on the basis that Texaco-Cities remained in the business of providing transportation by pipeline; the sales proceeds were invested back into that business; and the sale was not a cessation of a separate and distinct portion of Texaco-Cities' business.

      6. Oregon

        1. Simpson Timber Company v. Department of Revenue, 953 P. 2d 366 (Or. 1998)

          1. The Oregon Supreme Court held that delay compensation received in connection with the federal government's condemnation of a substantial tract of the taxpayer's timberland property constituted business income under the functional test.

          2. The "delay compensation" was paid in addition to the "just compensation" for the fair market value of the property because the federal government delayed for 10 years in making payment to the taxpayer.

          3. The delay compensation was based on hypothetical investment returns the just compensation would have earned in the hands of a "reasonably prudent investor."

          4. Taxpayer reported the delay compensation as interest income on its federal return.

          5. The court rejected taxpayer's argument that, because condemnation of land does not represent a voluntary disposition, it cannot be a disposition constituting an integral part of its regular business operations. The court held that condemnation is the equivalent of a forced sale.

          6. The court also rejected taxpayer's argument that, even if the just compensation could be considered business income, the delay compensation was of a different character. Arguably, the delay compensation was in effect the result of a long-term investment of the just compensation, during which period the funds were unavailable to the taxpayer.

          7. The court found, however, that the ultimate source of the income was the standing timber and the land, assets acquired and used as integral parts of the taxpayer's trade or business. The disposition of those assets produced business income. The amount received as delay compensation simply represented additional amounts from the disposition of business assets.

          8. The court distinguished in a footnote cases involving liquidations. The court noted that those cases did not involve either a condemnation or a partial disposition of assets. Instead, they involved complete liquidations or the sale of assets not used by the taxpayer in its regular business.

      7. Minnesota

        1. Firstar Corp. v. Commissioner of Revenue, 575 N.W. 2d 835 (Minn. 1998)

          1. Bank holding company's gain from the sale of real estate, including the building that housed its corporate headquarters in Wisconsin, was held to constitute nonbusiness income under the transactional test.

          2. The Minnesota Supreme Court applied the three factors that the Tennessee courts have applied– frequency and regularity of similar transactions, former business practices and subsequent use of the proceeds.

          3. Firstar had no former or current practice of selling commercial real estate.

          4. The court concluded that none of the proceeds were reinvested in ongoing business operations of the taxpayer, with the only arguable exception being Firstar's reinvestment of a portion of the proceeds in the acquisition of new banks. The balance of the proceeds was used to retire bonds secured by the Wisconsin property, to pay taxes on the gain, and to pay dividends to the shareholders.

          5. At the time of sale, Firstar occupied approximately 32 percent of the building. The remainder was used by third parties.

      8. North Carolina

        1. Polaroid Corp. v. Offerman, 507 S.E. 2d 284 (N.C. 1998)

          1. In a case involving the classification of a patent infringement damage award, the North Carolina Supreme Court held that the statutory definition contains two tests for business income.

          2. The court concluded that the award constituted business income under the functional test because the patents were an integral part of the taxpayer's trade or business operations.

          3. The court further held that North Carolina's definition of business income is broader than the UDITPA definition because it contains the phrase "acquisition, management and/or disposition of the property."

          4. In footnote 6, the court noted that "cases involving liquidation are in a category by themselves. Indeed, true liquidation cases are inapplicable to these situations because the asset and transaction at issue are not in furtherance of the unitary business, but rather a means of cessation."

      9. Alabama

        1. Uniroyal Tire Company v. Department of Finance, 779 So. 2d 227 (Ala. 2000)

          1. In 1985, in order to avoid a hostile takeover attempt, Uniroyal spun off various divisions into separate legal entities. The tire division was transferred to Uniroyal Tire Co. In 1986, Uniroyal Tire entered into a partnership with B. F. Goodrich Company. Following formation of the partnership, Uniroyal Tire's only asset was its interest in the partnership. Between 1986 and 1989, Uniroyal Tire treated the income received from the partnership as business income. In 1988, the partnership was recapitalized. Uniroyal Tire received $80 million and its ownership was reduced. In 1990, Uniroyal Tire sold its entire partnership interest and recognized a gain. Uniroyal Tire then liquidated by distributing the proceeds to its parent.

          2. The Alabama Supreme Court concluded that there was one test–transactional.

          3. The court held that the gains constituted nonbusiness income under this test. The court found that the sale of the partnership interest was not essential to the taxpayer's business operations, nor was it a regular business activity.

          4. The court also held that a complete liquidation and cessation of a business does not produce business income under the transactional test.

          5. The court went on to state that, even if a separate functional test exists, the "disposition" must be an integral part of the taxpayer's trade or business operations.

    2. Recent Developments

      1. Ohio

        1. Kemppel v. Zaino, 746 N.E. 2d 1073 (Ohio 2001)

          1. The Ohio Supreme Court held that income arising out of the liquidation of assets followed by dissolution of the corporation and distribution of the proceeds to the shareholders was nonbusiness income.

          2. The court recognized that the states are split on whether the statutory definition contains one or two tests for business income. The court further noted that some courts that have adopted the functional test have also recognized that the sale of assets as part of the partial or complete liquidation of a business is different from the sale of assets by a continuing business, citing Polaroid and Laurel Pipe Line.

          3. The court then concluded that the income was nonbusiness income under either test, simply stating that the income resulted from a liquidation followed by a dissolution of the corporation. It was a one-time event that terminated the business; it was not a sale in the regular course of a trade or business.

      2. Indiana

        1. The May Department Stores Company v. Indiana Department of Revenue, 749 N.E.2d 651 (Ind. 2001)

          1. Gains received by an out-of-state corporation from a court-ordered divestiture of an entire division were nonbusiness income under both the transactional and functional tests because the divestiture was not an essential part of the corporation's operations.

          2. The Indiana Tax Court held that there were two tests for business income.

          3. The court held that the gain was nonbusiness income under the transactional test because selling an entire division was not a regular business practice of the corporation.

          4. The court further held that the gain was nonbusiness income under the functional test. The court found that, while the division was an integral part of the corporation's business operations, the disposition of the assets was neither a necessary nor an essential part of the corporation's department store retailing operations. Rather, the court-ordered divestiture was for the benefit of competitors, not for the corporation.

      3. North Carolina

        1. Lenox, Inc. v. Tolson, 548 S.E. 2d 513 (N.C. 2001)

          1. The North Carolina Supreme Court held that the income from the sale of one of the operating divisions of a consumer products manufacturer constituted nonbusiness income under the functional test.

          2. The court stated that, in applying the functional test in the context of a liquidation, the focus should not be exclusively on whether the assets were integral to the corporation's regular business, but rather the totality of the circumstances should be considered.

          3. The court relied upon the fact that the sale was a complete liquidation, marking Lenox's complete cessation of a separate and distinct line of business, and that the proceeds from the sale were immediately distributed to its sole shareholder as a dividend.

        2. Directive No. CD-01-1 (November 20, 2001)

          1. A corporation's disposition of business assets will be considered nonbusiness income if the disposition is the liquidation of a separate and distinct line of business and results in a cessation of that line of business; and the company distributes all of the proceeds to its shareholders and does not reinvest any of the proceeds in the company.

      4. California

        1. Appeal of Jim Beam Brands Co., CCH Calif. Tax Rptr. ¶ 403-215 (Cal. 2001)

          1. Summary nonprecedential decision in which the sale of a unitary subsidiary's stock was held to be business income by the State Board of Equalization (SBE).

          2. The SBE held that there is no independent requirement that the disposition of the stock be an integral part of the taxpayer's trade or business operations under the functional test.

          3. The SBE further noted that there is no justification for carving out a partial liquidation exception to the functional test, declining to follow the North Carolina Court of Appeals decision in Lenox.

      5. Illinois

        1. Blessing/White, Inc., et al. v. Zehnder, 2002 Ill.App. Lexis 226, CCH Ill. Tax Rptr. ¶ 401-337 (Ill. 2002)

          1. A corporation realized nonbusiness income from the sale of all of its assets in a complete liquidation where the proceeds were distributed to the shareholders and not reinvested in the business.

          2. The court held that a "modified" form of the functional test should be applied when the disposition of the assets was made pursuant to a corporate liquidation in cessation of a business.

          3. Both the property and the liquidation of the assets must be essential to the taxpayer's regular trade or business operations.

      6. Pennsylvania

        1. Canteen Corp. v. Commonwealth, 792 A.2d 14 (Pa. 2002)

          1. Corporate subsidiary's gain attributable to its parent corporation's sale of stock to a third party was business income under the functional test where an IRC § 338(h)(10) election was made.

          2. The court recognized that while the sale of assets in connection with the liquidation of a business, whether partial or total, normally constitutes nonbusiness income for Pennsylvania tax purposes, this principle does not apply to a "deemed sale" of assets under a § 338(h)(10) election.

          3. The court held that the deemed asset sale was not a liquidation within the meaning of Laurel Pipe Line for Pennsylvania corporate income tax purposes.

  4. Miscellaneous Issues and Trends

    1. Is Use of Proceeds a Critical Factor?

      1. F. W. Woolworth Co. v. Taxation & Revenue Dept., 458 U.S. 354 (1982). The Supreme Court rejected reliance on whether dividends were commingled with general funds and used for general corporate purposes in determining the apportionability of the dividends.

      2. Allied-Signal, Inc. v. Director, Div. of Tax'n, 504 U.S. 768 (1992). The Supreme Court concluded that the use of the proceeds was not relevant in determining whether the gain from a stock sale was apportionable. Rather, the relevant inquiry is whether a unitary relationship existed between the seller and the entity whose stock was sold or whether the transaction served an operational rather than investment function.

      3. How do Woolworth and Allied-Signal square with the various state court decisions which have attached significance to the use of the proceeds in a liquidating transaction?

    2. Does or Should an I.R.C. § 338(h)(10) Election Affect the Business Income Determination?

    3. Is There Different Treatment of Liquidations in Separate Versus Combined States?

    4. Distortion in the Formula

      1. If a sale of a line of business generates business income under the functional test, what factors should be used to apportion the income? Should there be a better matching of the gain or loss with the factors in prior years?

      2. Where the gain is attributable to the increase in value of the holdings over time, how should the apportionment formula be adjusted?

      3. If the increase in value of the holdings is attributable to external market forces unrelated to the activities in the taxing state, how should the formula be adjusted?

      4. Can UDITPA § 18 be applied to correct a mismatching of income and factors?

        1. British Land (Maryland) Inc. v. Tax Appeals Tribunal of the State of New York, 647 N.E. 2d 1280 (NY. 1995)

          1. Delaware corporation established that a major portion of the gain on the sale of a Baltimore office building could not be attributed to its New York activities for corporate franchise tax purposes.

          2. Taxpayer demonstrated that the four factors principally responsible for the appreciation in the value of the Baltimore property–(a) improved economic climate in downtown Baltimore; (b) sound management resulting in high occupancy rates; (c) renovations to the building; and (d) acquisition of the fee interest–all had their economic impact on the Baltimore property prior to the commencement of the taxpayer's activities in New York.

        2. Compare In the Matter of the Petition of Fairchild Industries, Inc., CCH NY Tax Rptr. ¶ 403-612 (N.Y. 2000), where the New York Tax Appeals Tribunal distinguished British Land on the facts in connection with the sale of an out-of-state segment of the taxpayer's unitary business. The evidence presented indicated that the appreciation in the value of the out-of-state assets was attributable to the taxpayer's unitary business prior to the shutdown of its New York operations.

        3. Compare Firstar where the Minnesota Supreme Court noted that the entire appreciation in value of the Wisconsin property occurred before Firstar acquired its first bank holding company in Minnesota.

        4. Appeal of Scripps League Newspapers, Inc., (Cal. 1999)

          1. In an unpublished decision on rehearing, the SBE concluded that UDITPA § 18 could be applied to correct a distortion caused by the allocation of nonbusiness income to California from a liquidation sale of a nonunitary subsidiary.

        5. Eadington Fruit Company (Cal. 1978)

          1. Taxpayer's petition under California's counterpart to UDITPA § 18 was granted where its gain on the sale of a substantial portion of business assets, located outside of California, which was reported on the installment method, was apportioned on the basis of the apportionment factors in the year of sale, rather than the year of receipt.

          2. The Franchise Tax Board relied on Appeal of Donald M. Drake Company, CCH Calif. Tax Rptr. ¶ 205-598 (Cal. 1977) and the special construction contractor apportionment formula.

          3. "Apportionment of installment sale income on the basis of the factors in the year the income is reported or received would result in such income being apportioned by activities which had no connection with the earning of the income."

    5. Why Should Business Property, Which Has Generated Expenses and Deductions for the Taxpayer in Prior Years, Reducing Apportionable Business Income, Not Produce Business Income upon its Disposition?

    6. Trend to Define Business Income by Reference to Constitutional Standards

      1. A number of states have amended their business income definition to either delete all references to the transactional and functional tests, or to expand the definition to include reference to the constitutional standards of Allied-Signal.

        1. Pennsylvania amended its law in 2001.

          1. "'Business income' means income arising from transactions and activities in the regular course of the taxpayer's trade or business and includes income from tangible and intangible property if either the acquisition, the management or the disposition of the property constitutes an integral part of the taxpayer's regular trade or business operations. The income includes all income which is apportionable under the Constitution of the United States." 2001 Pa. Laws, HB 334, Par. No. 2375, section 11 (June 21, 2001) (emphasis added).

        2. Iowa Code Ann. Section 422.32(2)

          1. "It is the intent of the General Assembly to treat as apportionable business income all income that may be treated as apportionable business income under the Constitution of the United States."

      2. With this trend, it is likely that there will be greater development of what constitutes an "operational function" versus an "investment function."

    7. Does the Distinction between Business and Nonbusiness Income Have Any Continuing Validity Today?


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