Kewanee Industries, Inc. v. Reese
| Decision Date | 13 January 1993 |
| Docket Number | Nos. 20591,20732,s. 20591 |
| Parties | KEWANEE INDUSTRIES, INC., and The Pittsburg & Midway Coal Mining Co., Plaintiffs-Appellants, v. Gail REESE, Secretary of the Taxation and Revenue Department, State of New Mexico, Defendant-Appellee. KEWANEE INDUSTRIES, INC., Plaintiff-Appellant, v. STATE of New Mexico, ex rel., TAXATION AND REVENUE DEPARTMENT, Defendant-Appellee. |
| Court | New Mexico Supreme Court |
This case involves two separate appeals: Case No. 20,732 by Kewanee Industries, Inc. (Kewanee), and Case No. 20,591 by Kewanee and Pittsburgh & Midway Coal Mining Co. (P & M).1 At issue is the assessment of corporate and gross receipts taxes on rental income from the leases of two draglines. In Case No. 20,732, the dispositive issue is whether the rental income is treated as business or nonbusiness income. In Case No. 20,591, the issue is whether the rental income is exempted from the gross receipts tax because the transactions were "isolated or occasional" and thus outside the scope of the taxpayer's regular business. Because both cases involve the tax treatment of the same transactions, we consolidated the cases pursuant to SCRA 1986, 12-202(F)(2).
The Tax Administration Act, NMSA 1978, Secs. 7-1-1 to -82 (Repl.Pamp.1990 & Cum.Supp.1992) (Act), defines the procedure by which a taxpayer can call into question his or her liability for any tax. The Act requires that a taxpayer elect to dispute his liability for the payment of taxes either by protesting the assessment without making payment or by claiming a refund after making payment. Section 7-1-23.
In Case No. 20,732, Kewanee protested without payment and was, therefore, entitled to an administrative hearing. Section 7-1-24. Pursuant to Section 7-1-25, Kewanee appeals the adverse decision from that hearing before the Taxation and Revenue Department (Department). In Case No. 20,591, P & M paid the assessed gross receipts tax and filed a civil action for a refund in the Santa Fe County district court. Section 7-1-26. The district court entered judgment in favor of the Secretary of the Department, and pursuant to Section 7-1-26(A)(2), Kewanee and P & M appeal. We affirm on both appeals except on the issue of a penalty assessment in the first case.
Kewanee is incorporated in Delaware. Kewanee and P & M were both wholly-owned subsidiaries of Gulf Oil Corporation during the assessment period.2 Kewanee is an oil and gas company whose stock was acquired by Gulf in 1977. P & M is a coal company whose stock had been owned by Gulf for many years. On September 1, 1978, P & M sold to Kewanee a dragline for approximately $14,000,000. Kewanee leased the dragline back to P & M for a term of twenty years. On February 15, 1979, P & M sold to Kewanee a second dragline for approximately $14,000,000. This dragline was also leased back to P & M for a term of twenty years.3 A dragline is a large piece of equipment used in the surface mining of hard minerals.
Gulf, Kewanee, and P & M filed separate federal income tax returns in 1978. In that year, Kewanee had federal taxable income. P & M had zero federal taxable income. The sale-leaseback of the draglines directed by their common owner was intended to transfer federal depreciation and investment tax credits from P & M to Kewanee. Kewanee received rentals from P & M in the amount of $837,500 for each dragline for each year until the two leases were sold to Chrysler Financial Corporation after the 1986 payments. The total amount of rentals received by Kewanee was approximately $10,900,000.
In Case No. 20,732, Kewanee raises five points on appeal. The first four points concern the classification of the rental income from the draglines, and the fifth point questions whether a tax penalty was appropriate. Under Section 7-1-25(C), we may set aside the hearing officer's decision only if it was arbitrary, capricious, an abuse of discretion, not supported by substantial evidence, or not in accordance with the law. We do not reweigh the evidence but instead review the decision in the light most favorable to the hearing officer's decision. C & D Trailer Sales v. Taxation & Revenue Dep't, 93 N.M. 697, 700, 604 P.2d 835, 838 (Ct.App.1979). If more than one inference can be drawn from the evidence then the inference drawn by the hearing officer is conclusive. Waldroop v. O'Cheskey, 85 N.M. 736, 738, 516 P.2d 1119, 1121 (Ct.App.1973).
In 1981 and 1983, the two tax years subject to protest, Kewanee filed its corporate income tax return in New Mexico on a separate corporate entity basis. Kewanee reported no nonbusiness income in those returns. It included the rent payments in its apportionable business income, but did not include these payments in its New Mexico sales factor, nor did it include the cost of the draglines in its New Mexico property factor. The Department issued an assessment in the amount of $298,500 in corporate income tax, a penalty in the amount of $29,850, and interest in the amount of $138,771.75 for those tax years. Interest continues to accrue at $3,731.25 per month.
The dispositive issue is whether Kewanee's net income from the rental of the two draglines is classified as business or nonbusiness income. These terms are defined in the Uniform Division of Income for Tax Purposes Act, NMSA 1978, Secs. 7-4-1 to 4-21 (Repl.Pamp.1990) (UDI).4 Section 7-4-2 reads:
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;
* * * * * *
E. "nonbusiness income" means all income other than business income; * * * *
These statutory terms are further defined in the Department's Regulation UDI 2.2(1) (formerly I.T. 17(a)) which provides in part:
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 which are the elements of a particular trade or business. In general, all transactions and activities of the taxpayer which are dependent upon or contribute to the operations 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, and constitute integral parts of, a trade or business.
The first case to interpret Section 7-4-2, then Section 72-15A-17A, in New Mexico was Champion International Corp. v. Bureau of Revenue, 88 N.M. 411, 540 P.2d 1300 (Ct.App.1975). In Champion, a New York corporation was engaged in the manufacture and sale of a variety of wood products in all fifty states. The taxpayer argued that its income from interest on short-term investments, rents, and sales of logs for telephone poles was nonbusiness income and therefore should not be included in the apportionable base, but should be allocated to the state where the transactions occurred. The Court disagreed and found that the income in question was business income. Judge Sutin wrote the opinion and Judges Wood and Lopez specially concurred.
Judge Sutin defined "transactions and activity in the regular course of the taxpayer's trade or business" in Section 7-4-2(A) as "[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, 88 N.M. at 414, 540 P.2d at 1303. He concluded that this definition constituted a transactional test and a use test. If the transaction is one in which the enterprise normally engaged, the consequent income from the transaction is business income. Judge Sutin held that it was Champion's normal and customary practice to invest excess capital not immediately needed for business purposes. He also found it significant that the investment income was to be used by Champion in the future for business purposes. Id. at 415, 540 P.2d at 1304.
Judge Wood specially concurred, rejecting Champion's narrow view that limited the meaning of taxpayer's trade or business to its main or primary business. He stated:
[The UDI] makes no reference to "main business" or "main course of business." As I read [the section], it makes no difference whether the income derives from the main business, the principal business, the occasional business or the subordinate business so long as the income arises from the "regular course" of business.
Id. at 417, 540 P.2d at 1306. Judge Lopez's approach was to look to whether the income in question was "independent" of a taxpayer's business, relying on the case law addressing the unitary business concept to determine if the income is sufficiently "independent" to be nonbusiness income.5 Id. at 418, 540 P.2d at 1307.
In 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 (1975), the Court of Appeals construed the same section and stated that the definition of business income: "can be broken down into two parts, each with distinct meanings; (1) ' * * * transactions and activity in the regular course of the taxpayer's trade or business * * * ' and (2) situations in which ' * * * the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations * * * * ' " Id. at 522-23, 543 P.2d at 490-91. Relying on the second part of the definition,...
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