General Care Corp. v. Olsen

• Decision Date: 24 February 1986
• Citation: 705 S.W.2d 642
• Court: Tennessee Supreme Court
• Parties: GENERAL CARE CORPORATION, Appellee, v. Martha B. OLSEN, Commissioner of Revenue, Appellant.

Page 642

705 S.W.2d 642

GENERAL CARE CORPORATION, Appellee, v. Martha B. OLSEN, Commissioner of Revenue, Appellant.

Supreme Court of Tennessee at Nashville.

Feb. 24, 1986.

Charles L. Lewis, Deputy Atty. Gen., Nashville (W.J. Michael Cody, Atty. Gen., Nashville, of counsel), for appellant.

Charles A. Trost, Waller Lansden Dortch & Davis, William H. Neely, Waller Lansden Dortch & Davis, Nashville, for appellee.

OPINION

FONES, Justice.

Plaintiff, General Care Corporation, initiated this action in the Davidson County Chancery Court to recover state excise taxes paid under protest together with interest thereon from the date of payment. The chancellor entered judgment for plaintiff, and the defendant, the Commissioner of Revenue, appealed to this Court pursuant to T.C.A. § 16-4-108.

This appeal presents a single issue for review: whether capital gains from the sale of assets as a part of a corporate liquidation constitute "business earnings" within the meaning of T.C.A. § 67-4-804(a)(1), as the Commissioner contends, or "non-business earnings" within the meaning of T.C.A. § 67-4-804(a)(5), as plaintiff contends. The chancellor found the capital gains in question to be "non-business earnings."

The relevant facts are not in dispute. Plaintiff's predecessor in interest, the original General Care Corporation, was incorporated in Tennessee in 1968. During its existence the original General Care built four nursing homes and seven hospitals. It sold two of the nursing homes to private individuals, retained ownership of one, and converted one into a hospital. Four subsidiaries of the original General Care owned and operated the eight hospitals, five of which were located in Tennessee and three of which were located out of state, in Alabama, Georgia and Florida respectively. Neither the original General Care nor any of its subsidiaries ever sold a hospital outright to an unrelated third party, although minority interests ranging from 6 1/2% to 49 1/2% of the hospitals' real and personal property were sold to physicians on the staffs of seven of the hospitals. In 1980, the original General Care agreed to be acquired by Hospital Corporation of America [HCA]. To accomplish this, the original General Care caused its four hospital management subsidiaries to be liquidated and their assets distributed to it as a parent corporation. ¹ HCA purchased the interests of the original General Care shareholders for cash, and the original General Care was merged with a subsidiary of HCA known as HCA Acquisitions. HCA Acquisitions, the surviving corporation, then changed its name to General Care Corporation. This latter General Care succeeded to all the assets and liabilities of the original General Care and its subsidiaries, and is the plaintiff herein.

The parties to the merger obtained a private ruling from the Internal Revenue Service that for federal income tax purposes the transaction should be treated as a tax-free sale of assets by the original General Care to HCA Acquisitions pursuant to an I.R.C. § 337 liquidation plan, followed by complete liquidation of the original General Care and a taxable distribution to its shareholders of its assets. Tennessee requires the proceeds of I.R.C. § 337 sales to be recognized as "net earnings" under T.C.A. § 67-4-805 for state excise tax purposes, and accordingly, plaintiff filed with the Franchise and Excise Division of the Tennessee Department of Revenue a final excise tax return reflecting a capital gain of $61,306,126 for the period May 1, 1980 to September 4, 1980.

Plaintiff took the position that the capital gains were "non-business earnings" as defined in T.C.A. § 67-4-804(a)(5), and in accordance with T.C.A. § 67-4-810, allocated $35,512,050 to Tennessee and the balance of $25,794,076 among Alabama, Georgia and Florida. Plaintiff made a tentative tax payment of $2,641,000 based on estimated figures which it later revised. Plaintiff subsequently filed a claim for refund of $419,194 plus interest, contending that the amount of tax it owed was $2,221,806. The Commissioner took the position that the capital gains were "business earnings" within the meaning of T.C.A. § 67-4-804(a)(1). Based on the apportionment formula contained in T.C.A. § 67-4-811(a), the Commissioner determined the correct amount of tax to be $2,796,318.71, notified plaintiff of the deficiency, and demanded payment. Plaintiff paid involuntarily and under protest the sum of $201,076.21, which represented the assessed deficiency of $155,318.71 plus interest.

Tennessee's excise tax on corporate earnings, enacted in 1976 and presently codified at T.C.A. § 67-4-801, et seq., is taken from the Uniform Division of Income for Tax Purposes Act [UDITPA], a model act prepared by the National Conference of Commissioners on Uniform State Laws. Under the Act, a corporation doing business in several states must divide its income among those states for tax purposes. T.C.A. § 67-4-809. The method by which corporate income is divided depends upon whether the income is classified as "business earnings" or "non-business earnings." ² T.C.A. § 67-4-804(a) defines the terms in the following manner:

67-4-804. Miscellaneous definitions.

--(a) As used in this part, unless the context otherwise requires:

(1) "Business earnings" means earnings arising from transactions and activity in the regular course of the taxpayer's trade or business and includes earnings 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...

(5) "Nonbusiness earnings" means all earnings other than business earnings...

Income classified as "business earnings" is "apportioned" under T.C.A. § 67-4-811. Apportionment takes all the corporate income and divides it among the various states in which the taxpayer operates according to a three-factor formula that takes into account the corporation's property, payroll, and sales. Income classified as "non-business earnings" is generally traced to its source in a particular state and "allocated" to that state under T.C.A. § 67-4-810. In the case at bar, a larger portion of the gains would be attributed to Tennessee under the apportionment formula than under the allocation method.

In other jurisdictions the UDITPA definition of "business income" has given rise to two different judicial interpretations. Several courts have employed what has been termed the "transactional test" in determining whether income is to be classified as business income or non-business income. The transactional test is rooted in the statutory phrase, "earnings arising from transactions and activity in the regular course of the taxpayer's trade or business." [Emphasis added.] One court has held that the phrase refers to "[b]usiness deals and the performance of a specific function in the normal, typical, customary, or accustomed policy or procedure of the taxpayer's trade or business." Champion Int'l Corp. v. Bureau of Revenue, 88 N.M. 411, 540 P.2d 1300, 1303 (App.1975).

Thus, under the transactional test, the "controlling factor by which business income [is identified] is the nature of the particular transaction giving rise to the income." Western Natural Gas Co. v. McDonald, 202 Kan. 98, 446 P.2d 781, 783 (1968). The frequency and regularity of similar transactions and the former practices of the business are pertinent considerations. Atlantic Richfield Co. v. State, 198 Colo. 413, 601 P.2d 628, 631 (1979); Western Natural Gas, 446 P.2d at 784.

Another relevant inquiry concerns the taxpayer's subsequent use of the income. Under the transactional test, earnings held for use in the regular course of on-going business operations or expended to acquire assets to be used in the regular course of future business activities, have been held to be properly apportionable as business income. Champion Int'l, 540 P.2d at 1304, Sperry & Hutchinson Co. v. Department of Revenue, 270 Or. 329, 527 P.2d 729, 731 (1974). Conversely, the sale of all of a company's assets as a part of a plan of complete liquidation has been held under the transactional test to give rise to non-business income, on the ground that such a transaction was of an extraordinary nature, outside the scope of the regular course of business operations. Western Natural Gas, 446 P.2d at 784; McVean &amp Barlow, Inc. v. New Mexico Bureau of Revenue, 88 N.M. 521, 543 P.2d 489 (App.1974).

Other jurisdictions have concluded that the UDITPA definition of "business earnings" contains an alternative "functional test" by which earnings may be categorized as business income. Adherents of the functional test focus on the statute's second clause: "... earnings 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." [Emphasis added.] Whereas proponents of the transactional test treat this clause as clarifying language which merely modifies the substantive part of the definition, proponents of the functional test contend that it creates an independent test by which income may be classified.

Under the transactional test, the use or function of an asset in the taxpayer's business is not a determinative criterion, Western Natural Gas, 446 P.2d at 783, but under the functional test, the income from the sale of an asset will be considered business income if the asset produced business income while it was owned by the taxpayer. District of Columbia v. Pierce Assocs., Inc., 462 A.2d 1129, 1131 (D.C.App.1983) illustrates: "If the property had an integral function in the taxpayer's unitary business, its income properly can be apportioned and taxed as business income, even though the transaction itself does not reflect the taxpayer's normal trade or business [footnote omitted]." Under the functional test, "the extraordinary nature or the infrequency of [a]...