Ex parte Uniroyal Tire Co.

• Decision Date: 04 August 2000
• Citation: 779 So.2d 227
• Parties: Ex parte UNIROYAL TIRE COMPANY. (Re Uniroyal Tire Company v. State Department of Revenue).
• Court: Alabama Supreme Court

779 So.2d 227

Ex parte UNIROYAL TIRE COMPANY.

(Re Uniroyal Tire Company v. State Department of Revenue).

1981928.

Supreme Court of Alabama.

August 4, 2000.

Daniel H. Markstein III and Thomas H. Brinkley of Maynard, Cooper & Gale, P.C., Birmingham, for petitioner.

Jeff Patterson, asst. counsel, Department of Revenue, and asst. atty. gen., for respondent.

Bruce P. Ely and Peter C. Bond of Tanner & Guin, L.L.C., Tuscaloosa, for amicus curiae Committee on State Taxation.

COOK, Justice.

We granted the petition of Uniroyal Tire Company ("Uniroyal") for certiorari review of a judgment of the Court of Civil Appeals. That court affirmed a judgment in favor of the State Department of Revenue (the "Department"), holding that Uniroyal was liable for $2,148,178 in corporate income taxes and interest, on a capital gain of $99.7 million it realized from the liquidation in 1990 of all its business assets.

The essentially undisputed facts are set forth in the opinion of the Court of Civil Appeals as follows:

"In 1986, Uniroyal entered into a partnership with the B.F. Goodrich Company, wherein both corporations transferred their assets to the partnership and each received a 50% partnership interest. Thereafter, Uniroyal's only asset was its partnership interest, and between 1986 and 1989 Uniroyal treated income received from the partnership as business income. Then, in 1988, the partnership was recapitalized, resulting in Uniroyal's percentage of ownership in the partnership being reduced and in Uniroyal's receiving $80 million in cash.

"Later, in 1990, Uniroyal sold its entire partnership interest for approximately $260,600,000 and realized a capital gain of approximately $99.7 million. On its 1990 Alabama tax return, Uniroyal treated the $99.7 million as nonbusiness income. The Department contested the return, maintaining that the $99.7 million was business income, and assessed corporate income tax accordingly. Uniroyal appealed to the Department's Administrative Law Division...."

Uniroyal Tire Co. v. State Dep't of Revenue, 779 So.2d 221, 222 (Ala.Civ.App.1999).

The Department assessed the tax on the basis of the term "business income," as it is defined in Ala.Code 1975, § 40-27-1, Art. IV, 1.(a), and in the Revenue Department Regulations then in effect, specifically Ala.Admin.Code r. 810-3-31.02(1)(a)4.(ii):¹

"[§ 40-27-1, Art. IV, 1.(a) ] `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 constitute integral parts of the taxpayer's regular trade or business operations."

"[Reg. 810-3-31-.02(1)(a)4.(ii) ] As a general rule, gain ... 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 to produce business income."

Uniroyal appealed the assessment to the Department's Administrative Law Division. The administrative law judge ("the ALJ") defined the issue as follows:

"The primary issue is whether [Uniroyal's] gain from the sale of a partnership interest in 1990 was business income, as defined by the above statute, and thus apportionable to Alabama, or `nonbusiness income,' and thus allocable entirely to [Uniroyal's] state of commercial domicile, Connecticut.

". . . .

"Generally speaking, [the statute] requires a corporation to apportion its business income among the various states in which the corporation does business using a standard three-factor formula of property, payroll, and sales. All other nonbusiness income is allocated directly to the corporation's state of commercial domicile...."

(Emphasis added.) The ALJ ruled in favor of Uniroyal, holding that the capital gain from the liquidation of partnership assets was "nonbusiness" income.

The Department appealed to the Montgomery Circuit Court, which entered a summary judgment in favor of the Department. Relying on Reg. § 810-3-31.02(1)(a)4.(ii), the trial court explained:

"`Here, Uniroyal admitted that its partnership interest produced "business" income while it was owned by Uniroyal. Contrary to the implication of the [ALJ], this regulation does not conflict with the statutory definition of "business" income and is not inconsistent with that definition. Instead, the regulation is reasonable.'"

Uniroyal appealed to the Court of Civil Appeals, which, over the strenuous dissent of two judges, affirmed the summary judgment. The majority stated: "We agree with the analysis of the North Carolina Supreme Court in Polaroid Corp. v. Offerman, 349 N.C. 290, 507 S.E.2d 284 (1998), and we find no conflict between the regulation and the statute." 779 So.2d at 223. Uniroyal then sought certiorari review in this Court.² We reverse and remand.

The construction of § 40-27-1, Art. IV, 1.(a), and its relationship with the Department regulations are questions of first impression in this Court. Section 40-27-1, Art. IV, 1.(a), is a provision of the Multi-state Tax Compact (the "MTC"), as enacted by the Alabama Legislature in Act No. 395, 1967 Ala.Acts 982 (Reg.Session). The MTC "was created in 1966 to establish a uniform system for taxing multistate taxpayers and became effective in 1967 after various states had adopted it." State Dep't of Revenue v. MGH Management, Inc., 627 So.2d 408, 409 (Ala.Civ.App.1993). To date, there are 21 "compact member states"—including Alabama—that is, states that have adopted the MTC. 1 All States Tax Guide (RIA) ¶ 564 (June 6, 2000). Article IV of the MTC incorporated the Uniform Division of Income for Tax Purposes Act (the "UDITPA").

The UDITPA was "approved" in 1957 by the National Conference of Commissioners on Uniform State Laws and the American Bar Association and "recommended... for adoption by the states." Comment, A Matter of (Statutory) Interpretation: North Carolina Recognizes the Functional Test of Corporate Taxation in Polaroid Corp. v. Offerman, 77 N.C.L.Rev. 2326, 2327 (1999). Its purpose was similar to that of the MTC, namely, "to address the problem of multiple taxation and to create a uniform method for allocating corporate income among the states entitled to tax a portion thereof." Id. The Alabama Legislature took verbatim from the UDITPA, § 1(a), the definition of "business income" in § 40-27-1, Art. IV, 1.(a), which is at issue in this case.

But the uniformity sought by the proponents of the UDITPA/MTC has been compromised by judicial disagreement over the definition of the term "business income." This disagreement has evolved into what is essentially a dichotomy in judicial construction of the definition. Indeed, two separate "tests" have developed as a result of the judiciary's attempts to determine when a gain is "business income."

A number of courts construing language functionally identical to that of § 40-27-1, Art. IV, 1.(a), have concluded that their statute contained only what is popularly described as the "transactional" test. See, e.g., Phillips Petroleum Co. v. Iowa Dep't of Revenue & Fin., 511 N.W.2d 608 (Iowa 1993); Western Natural Gas Co. v. McDonald, 202 Kan. 98, 446 P.2d 781, 783 (1968); McVean & Barlow, Inc. v. New Mexico Bureau of Revenue, 88 N.M. 521, 543 P.2d 489 (Ct.App.), cert. denied, 89 N.M. 6, 546 P.2d 71 (N.M.1975); General Care Corp. v. Olsen, 705 S.W.2d 642 (Tenn. 1986). Proponents of the transactional test find it "rooted in the statutory phrase, `earnings arising from transactions and activity in the regular course of the taxpayer's trade or business.'" General Care, 705 S.W.2d at 644 (emphasis added in General Care ). "Thus, under the transactional test, the `controlling factor by which business income [is defined] is the nature of the particular transaction giving rise to the income.' ... The frequency and regularity of similar transactions and the former practices of the business are pertinent considerations." Id. (quoting McDonald, supra).

Other courts construing the same language have concluded that their statute also contains an alternative test, which is popularly known as the "functional" test. See, e.g., Pledger v. Getty Oil Exploration Co., 309 Ark. 257, 831 S.W.2d 121 (1992); Texaco-Cities Serv. Pipeline Co. v. McGaw, 182 Ill.2d 262, 230 Ill.Dec. 991, 695 N.E.2d 481 (1998); and Laurel Pipe Line Co. v. Commonwealth, 537 Pa. 205, 642 A.2d 472 (1994); cf. Simpson Timber Co. v. Department of Revenue, 326 Ore. 370, 953 P.2d 366 (1998) (Durham, J., concurring). Proponents of the functional test find it rooted in that second clause of the statute, which reads: "and includes income from tangible and intangible property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations." "More broadly [than under the transactional test], under the functional test, all gain from the disposition of a capital asset is considered business income if the asset disposed of was `used by the taxpayer in its regular trade or business operations.'" Texaco-Cities Serv.,182 Ill.2d at 269,230 Ill.Dec. 991,695 N.E.2d at 484 (emphasis added). "Under the functional test ..., the extraordinary nature or infrequency of the sale is irrelevant." Id.,182 Ill.2d at 269,230 Ill.Dec. 991,695 N.E.2d at 484. Proponents of this view hold that "income constitutes business income if either one of the above tests is met." Id. (emphasis added).

The "functional test" is embodied in revenue department regulations adopted by various states. See Appeal of Chief Indus., Inc., 255 Kan. 640, 646-47, 875 P.2d 278, 283 (1994). Specifically, 15 states have adopted regulations promulgated by the Multistate Tax Commission "on allocation and apportionment of income generally and for specialized businesses" (the "Model Regulations"). 1 All States Tax Guide (RIA) ¶ 226-B (October 19, 1999). Alabama is among these 15 states. Id.; see...