Harris Corp. v. Ariz. Dep't of Revenue

• Decision Date: 26 November 2013
• Docket Number: No. 1 CA–TX 11–0006.,1 CA–TX 11–0006.
• Citation: 233 Ariz. 377,674 Ariz. Adv. Rep. 44,312 P.3d 1143
• Parties: HARRIS CORPORATION and Consolidated Subsidiaries, Plaintiffs/Appellants, v. ARIZONA DEPARTMENT OF REVENUE, Defendant/Appellee.
• Court: Arizona Court of Appeals

233 Ariz. 377

312 P.3d 1143

674 Ariz. Adv. Rep. 44

HARRIS CORPORATION and Consolidated Subsidiaries, Plaintiffs/Appellants,

v.ARIZONA DEPARTMENT OF REVENUE, Defendant/Appellee.

No. 1 CA–TX 11–0006.

Court of Appeals of Arizona,

Division 1.

Nov. 26, 2013.

Steptoe & Johnson, LLP, Phoenix By Pat Derdenger, Bennett Evan Cooper, for Plaintiffs/Appellants.

Arizona Attorney General's Office, Phoenix By Kimberly Cygan for Defendant/Appellee.

Bade Baskin Richards, PLC, Tempe By William A. Richards and Multistate Tax Commission, Washington, D.C. By Shirley Sicilian and Bruce J. Fort for Amicus Curiae Multistate Tax Commission.

OPINION

GEMMILL, Judge.

¶ 1 The issue in this corporate taxation case is whether certain income constitutes “business income” or “nonbusiness income” under Arizona Revised Statutes (“A.R.S.”) section 43–1131. The definition of “business income” in A.R.S. § 43–1131(1) is set forth in two clauses. We hold that Arizona may tax corporate income as “business income” if the income satisfies either definitional clause. Because the tax court correctly applied the statute to the facts, we affirm the tax court's grant of summary judgment to the Arizona Department of Revenue (the “Department”).

BACKGROUND

¶ 2 Harris Corporation (“Harris”) is a Delaware corporation with its executive offices in Melbourne, Florida. It provides voice, data, and video telecommunications products and related services.

¶ 3 Harris and its subsidiaries (“Taxpayer”) elected to file Arizona corporate income tax returns on a consolidated basis ¹ pursuant to A.R.S. § 43–947(A) for tax years June 30, 1997 to June 30, 2001. Those returns reflect three categories of income at issue herein: (1) gains recognized on the contribution of assets to a joint venture with General Electric; (2) proceeds from the sale of the Lanier Medical Transcription business line; and (3) royalties received from patent rights acquired by Harris and held by Harris Semiconductor Patents, Inc. (“Harris Semiconductor”), along with income from the sale of stock and other assets by Harris subsidiaries engaging in investment activities.

¶ 4 On its consolidated Arizona returns, Taxpayer treated the income, expenses, and losses from its business operations as “business income” but treated gains on the dispositions in question as “non-business income.” Following an audit, the Department issued a notice of proposed assessment. Taxpayer protested, and appealed to the Arizona Tax Court in accordance with A.R.S. § 42–1254(C). The parties filed cross-motions for summary judgment on whether the proceeds of the transactions qualified as business income. The tax court granted summary judgment in favor of the Department and filed a formal judgment. Taxpayer timely appeals.

ANALYSIS

I.A.R.S. § 43–1131(1) Provides Two Alternative Clauses Describing “Business Income”

¶ 5 This court reviews the tax court's grant of summary judgment de novo. Citizens Telecomm. Co. of White Mountains v. Ariz. Dep't of Revenue, 206 Ariz. 33, 38, ¶ 20, 75 P.3d 123, 128 (App.2003). We also apply the de novo standard when reviewing the tax court's interpretation of statutes. M.D.C. Holdings, Inc. v. State ex rel. Ariz. Dep't of Revenue, 222 Ariz. 462, 467, 216 P.3d 1208, 1213 (App.2009).

¶ 6 Arizona imposes a corporate income tax “upon the entire Arizona taxable income of every corporation.” A.R.S. § 43–1111; seeA.R.S. § 43–102(A)(5) (corporations are subject to Arizona tax on income earned from sources within the state). When corporations conduct activities in multiple states, income must be apportioned or allocated among various states. In an effort to properly account for the income of such corporations, the Arizona Legislature enacted a modified version of the Uniform Division of Income for Tax Purposes Act (“UDITPA”) in 1983. A.R.S. §§ 43–1131 to –1150; see Walgreen Arizona Drug Co. v. Arizona Dep't of Revenue, 209 Ariz. 71, 72, ¶ 7, 97 P.3d 896, 897 (App.2004). Under UDITPA, business income is “generally ‘apportioned’ between the states in which the corporation does business using a formula defined in the statutes.” Arizona Dep't of Revenue v. Cent. Newspapers, Inc., 222 Ariz. 626, 629, ¶ 12, 218 P.3d 1083, 1086 (App.2009) (citing A.R.S. § 43–1139(A)). In contrast, “certain nonbusiness income is ‘allocated’ to designated states, based on factors such as the location of property and the taxpayer's commercial domicile.” Id. (citing A.R.S. §§ 43–1134 to –1138).

¶ 7 UDITPA apportions business income to this state through a formula for multi-state corporations using their property, sales, and payroll. Walgreen, 209 Ariz. at 72, ¶¶ 7–8, 97 P.3d at 897. Arizona allocates nonbusiness income, such as capital gains from the sale of intangible property and interest income, to the state in which the taxpayer is domiciled. A.R.S. §§ 43–1136(C), 43–1137; see generally 1 Jerome R. Hellerstein et al., State Taxation ¶ 9.01, at 9–7 n. 2 (3d ed.2009) (hereinafter “ Hellerstein ”) (“ ‘allocation’ refers to the attribution of a particular type of income to a designated state, whereas ‘apportionment’ refers to the division of the tax base by formula”). Other nonbusiness income, such as net rents, royalties, and capital gains from the sale of real or tangible personal property, is allocated to the state where the property is located. A.R.S. §§ 43–1135(A), (B), 43–1136(A), (B).

¶ 8 Section 43–1131, A.R.S., defines “business income” and “nonbusiness income” as follows:

As used in this article, unless the context otherwise requires:

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 constitute integral parts of the taxpayer's regular trade or business operations.

* * *

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

¶ 9 The courts in several states adopting these UDITPA definitions have recognized that “business income” includes two alternative definitional clauses: the so-called “transactional” test from the first clause (“income arising from transactions and activity in the regular course of the taxpayer's trade or business”), and the so-called “functional” test from the second clause (“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”). See, e.g., Texaco–Cities Serv. Pipeline Co. v. McGaw, 182 Ill.2d 262, 230 Ill.Dec. 991, 695 N.E.2d 481, 484 (1998) (addressing definition of business income essentially identical to A.R.S. § 43–1131(1)). Because a number of courts and various commentators utilize these descriptors, we will also use them for convenience as shorthand references to the respective clauses of § 43–1131(1). We emphasize, however, that proper interpretation of § 43–1131(1) is based on the statutory language and not on the labels applied by others. And we caution against use of the terms “transactional” or “functional”—rather than the actual statutory language—to evaluate whether particular income should be categorized as business or nonbusiness income.

¶ 10 To constitute business income under the transactional test, the income must be produced by an activity in the regular course of the taxpayer's business operations. Under this test, the “controlling factor by which business income is identified is the nature of the particular transaction giving rise to the income.” Gen. Care Corp. v. Olsen, 705 S.W.2d 642, 644 (Tenn.1986). The functional test describes business income as income from property if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations. Courts have found that under the functional test, the focus is on the relationship between the asset and the business, and the extraordinary nature or infrequency of the sale is irrelevant. See, e.g., Texaco–Cities, 230 Ill.Dec. 991, 695 N.E.2d at 484–85.

¶ 11 Review of the case law indicates that courts are divided on the interpretation of this statute. Some courts hold that corporate income is business income if it satisfies either the transactional or the functional test. Gannett Satellite Info. Network, Inc. v. State, Dep't of Revenue, 348 Mont. 333, 201 P.3d 132 (2009); Hoechst Celanese Corp. v. Franchise Tax Bd., 25 Cal.4th 508, 106 Cal.Rptr.2d 548, 22 P.3d 324 (2001); Simpson Timber Co. v. Oregon Dep't of Revenue, 326 Or. 370, 953 P.2d 366 (1998); Texaco–Cities, 182 Ill.2d 262, 230 Ill.Dec. 991, 695 N.E.2d 481;Pledger v. Getty Oil Exploration Co., 309 Ark. 257, 831 S.W.2d 121 (1992); Dist. of Columbia v. Pierce Assocs., Inc., 462 A.2d 1129 (D.C.1983). Other courts hold that there is one transactional test, and the second clause merely describes examples of income within the definition. Phillips Petroleum Co. v. Iowa Dep't of Revenue, 511 N.W.2d 608 (Iowa 1993) (superseded by Iowa Code § 422.32); W. Nat'l Gas Co. v. McDonald, 202 Kan. 98, 446 P.2d 781 (1968) (superseded by Kan. Stat. § 79–3271(a)); Gen. Care Corp., 705 S.W.2d 642 (superseded by Tenn.Code Ann. § 67–4–2004).

¶ 12 The parties and Amicus Multistate Tax Commission (“MTC”) agree that the first clause of A.R.S. § 43–1131(1) imposes a transactional test. They disagree as to whether income, in order to qualify as business income, must always satisfy the functional requirements in the second clause. Taxpayer contends that the Department—by construing the clauses to provide alternate tests—has adopted an overly broad definition of “business income,” thereby encompassing income that should be allocated to Florida and not taxed in Arizona.

¶ 13 The primary goal of statutory interpretation is to ascertain and implement the legislative intent. Obregon v. Indus. Common, 217 Ariz. 612, 614, ¶ 11, 177 P.3d 873, 875 (App.2008). “We look first to the plain...