Laurel Pipe Line Co. v. Com., Bd. of Finance and Revenue

• Decision Date: 26 May 1994
• Citation: 537 Pa. 205,642 A.2d 472
• Parties: LAUREL PIPE LINE COMPANY, Appellant, v. COMMONWEALTH of Pennsylvania, BOARD OF FINANCE AND REVENUE, Appellee.
• Court: Pennsylvania Supreme Court

Page 472

642 A.2d 472

537 Pa. 205

LAUREL PIPE LINE COMPANY, Appellant, v. COMMONWEALTH of Pennsylvania, BOARD OF FINANCE AND REVENUE, Appellee.

Supreme Court of Pennsylvania.

Argued May 5, 1993.

Decided May 26, 1994.

George T. Bell, Harrisburg, for appellant.

Michael A. Roman, Dep. Atty. Gen., for appellee.

Before NIX, C.J., and LARSEN, FLAHERTY, ZAPPALA, PAPADAKOS, CAPPY and MONTEMURO, JJ.

OPINION

NIX, Chief Justice.

This is a direct appeal from the Order of the Commonwealth Court which affirmed the Order of the Board of Finance and Revenue. The Commonwealth Court and the Board of Finance and Revenue refused to characterize as nonbusiness income the gain on the sale of an idle pipeline and related assets by Appellant, Laurel Pipe Line Company ("Laurel"). For the reasons that follow, we reverse.

Laurel and the Board of Finance and Revenue entered into a stipulation of facts which the Commonwealth Court adopted as the factual findings in this case. The stipulation indicates that Laurel is an Ohio corporation engaged in the business of transporting refined petroleum products from refinery and pipeline connections from the Philadelphia area to Pittsburgh and intermediate points. From 1983 until 1986, Laurel also operated a pipeline from Aliquippa, Pennsylvania, to Cleveland, Ohio.

As a result of shifting distribution patterns and insufficient volume, Laurel discontinued operation of the Aliquippa-Cleveland pipeline in 1983. On December 22, 1986, Laurel sold this pipeline, along with related assets, ¹ for a gain of $3,766,047. Fifteen days later, Laurel's Board of Directors declared dividends equal to the entire after-tax net proceeds resulting from the sale and distributed those proceeds to Laurel's stockholders. None of the proceeds were used by Laurel to acquire any asset for use in future business operations or to generate income for use in future business operations.

At the time that it filed its 1986 Pennsylvania corporate net income tax return, ² Laurel treated the gain from the sale of the Aliquippa-Cleveland pipeline as nonbusiness income and allocated the gain between Pennsylvania and Ohio. ³ On June 2, 1988, the Pennsylvania Department of Revenue entered into a settlement with Laurel whereby the entire gain from the sale of the pipeline was reclassified as business income subject to apportionment. ⁴ Laurel filed a Petition for Resettlement with the Board of Appeals which was denied. A Petition for Review was then filed by Laurel with the Board of Finance and Revenue. That petition was also denied.

On appeal to the Commonwealth Court, Laurel raised three alternative issues concerning whether all or a part of the gain from the sale of the Aliquippa-Cleveland pipeline was taxable by the Commonwealth. The Commonwealth Court rejected each argument seriatim and affirmed the Order of the Board. We now reverse.

Laurel's first contention is that the gain on the sale of the Aliquippa-Cleveland pipeline is nonbusiness income which should be allocated between Pennsylvania and Ohio based upon the situs of the property. For corporate net income tax purposes, Pennsylvania divides income into two categories: business income and nonbusiness income. 72 P.S. § 7401(3)2. (a)(1)(A), (D). The first category, business income, is defined as "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." 72 P.S. § 7401(3)2. (a)(1)(A). Business income of pipeline companies is apportioned to Pennsylvania according to a single factor which is the revenue-barrel ratio. ⁵ 72 P.S. § 7401(3)2. (c).

The other category of income, nonbusiness income, consists of "all income other than business income." 72 P.S. § 7401(3)2. (a)(1)(D). Nonbusiness income is "allocated to the situs of the income producing property." Welded Tube Co. of America v. Commonwealth, 101 Pa.Commw. 32, 41, 515 A.2d 988, 993 (1986).

Notwithstanding the instant case, the only Pennsylvania decision that has addressed the distinction between business and nonbusiness income is Welded Tube Co. of America v. Commonwealth, 101 Pa.Commw. 32, 515 A.2d 988 (1986). In Welded Tube, the taxpayer operated two plants for the manufacture of tubing, one in Philadelphia and one in Chicago. In 1979, the Philadelphia plant was sold for a gain and the taxpayer treated the gain as business income to be apportioned. The Department of Revenue disagreed and characterized the gain as nonbusiness income to be allocated entirely to Pennsylvania.

On appeal, the Commonwealth Court reversed and found that the gain on the sale of the Philadelphia plant was business income. Id. at 46, 515 A.2d at 995. In so holding, the court cited cases from other jurisdictions and stated that the two clauses that comprised the statutory definition of business income, 72 P.S. § 7401(3)2. (a)(1)(A), contained two alternative tests for determining "whether certain income is properly classified as business income or nonbusiness income." Id. at 42, 515 A.2d at 993.

The first test for classifying income is the transactional test which is derived from the first clause of the statutory definition: "income arising from transactions and activity in the regular course of the taxpayer's trade or business." Id. Under the transactional test, "the particular transaction giving rise to the income is measured against the 'frequency and regularity' of similar transactions in the past practices of the business." Id. at 43, 515 A.2d at 993 (citation omitted).

The parties in this case agree that the gain on the sale of the Aliquippa-Cleveland pipeline does not meet the transactional test. Therefore, the only issue concerning the classification of the gain as business or nonbusiness income is whether it meets the functional test.

The functional test is based upon the second clause of the statutory definition: "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.' " Id. at 43, 515 A.2d at 993-94. Income meets the functional test if the gain arises from the sale of an asset which produced business income while it was owned by the taxpayer. Id. at 43-44, 515 A.2d at 994. The court in Welded Tube found that both the transactional and the functional tests were met because it was a regular practice of the taxpayer to acquire property in the expansion of its business and because the gain on the sale was reinvested in the business. Id. at 44-46, 515 A.2d at 994-95.

In the court below, Laurel argued that the sale of the Aliquippa-Cleveland pipeline constituted a partial liquidation of the company's business and was not a transaction in which it regularly engaged. The Commonwealth Court did not directly address this issue, but instead found that the gain on the sale of the pipeline met the functional test. Laurel Pipe Line Co. v. Commonwealth, 150 Pa.Commw. 135, 144, 615 A.2d 841, 846 (1992). The court correctly noted that Laurel "operated the Aliquippa-Cleveland pipeline from 1976 to 1983" and that "[i]n its Pennsylvania corporate net income tax filings for that time span, [Laurel] reported net revenues from the operation of the pipeline as business income subject to apportionment. Therefore, the pipeline produced business income while [Laurel] owned it." Id. The court then stated:

the Aliquippa-Cleveland pipeline was only one of the pipelines owned and operated by [Laurel]. When the Aliquippa-Cleveland pipeline became unprofitable and was idled in 1983, the sale of the pipeline was necessary to [Laurel]'s continued, overall business viability and was thus an integral part of [Laurel]'s regular course of business.

Id.

The statutory definition of business income requires that "the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations." 72 P.S. § 7401(3)2. (a)(1)(A) (emphasis added). The Commonwealth Court has thus stated that a singular disposition of an unprofitable pipeline is an integral part of the company's regular business because, if not sold, the company's other business would suffer financially. We disagree with this conclusion.

The Aliquippa-Cleveland pipeline had been idle for over three years prior to the time that it was sold. In our view, the pipeline was not disposed of as an integral part of Laurel's regular trade or business. Rather, the effect of the sale was that the company liquidated a portion of its assets. This is evidenced by the fact that the proceeds of the sale were not reinvested back into the operations of the business, but were distributed entirely to the stockholders of the corporation. Although Laurel continued to operate a second, independent pipeline, the sale of the Aliquippa-Cleveland pipeline constituted a liquidation of a separate and distinct aspect of its business. ⁶

Laurel also takes exception to the conclusion of the Commonwealth Court that the pipeline was sold because it was unprofitable or because the income from the sale was needed to maintain the company's viability. The Commonwealth responds that "such a conclusion is clearly a fair inference from the stipulated facts that the assets were 'shut down' [sic] because of 'shifting distribution patterns and insufficient volume.' " Brief of Appellee at 10. Based upon our review of the record, we find this to be a tenuous inference.

The Commonwealth urges us to view the three year period from the shutdown of the pipeline until its final disposition as indicative of the fact that the asset was unattractive to potential buyers and therefore difficult to sell. There is nothing in the record indicating the date on which the pipeline was placed on sale. We may not therefore...