Lenox, Inc. v. Tolson

• Decision Date: 20 July 2001
• Docket Number: No. 17A01.,17A01.
• Citation: 353 N.C. 659,548 S.E.2d 513
• Court: North Carolina Supreme Court
• Parties: LENOX, INCORPORATED v. E. Norris TOLSON, Secretary of the North Carolina Department of Revenue.

548 S.E.2d 513

353 N.C. 659

LENOX, INCORPORATED v. E. Norris TOLSON, Secretary of the North Carolina Department of Revenue.

No. 17A01.

Supreme Court of North Carolina.

July 20, 2001.

Wilson & Iseman, L.L.P., by G. Gray Wilson; James M. Iseman, Jr.; and Kevin B. Cartledge, Winston-Salem, for plaintiff-appellee.

Roy A. Cooper, Attorney General, by Kay Linn Miller Hobart, Assistant Attorney General, for defendant-appellant.

WAINWRIGHT, Justice.

Lenox, a New Jersey-based corporation, operates as a conglomerate corporation with multistate operating divisions, including North Carolina. Since 1983, Lenox has been a wholly owned subsidiary of the Brown-Forman Corporation. At all relevant times, Lenox has been engaged in the business of manufacturing and selling numerous consumer products, including fine china, fine crystal, dinnerware, silverware, collectibles, candles, luggage and fine jewelry. In 1970, Lenox established its ArtCarved subsidiary division to manufacture and sell fine jewelry. Art-Carved was a functionally and financially distinct entity from Lenox. ArtCarved, which had its principal place of business in New York, maintained its own centralized management and financial systems apart from those of Lenox and had its own president, chief financial officer, controller and accounting and human resources staff. In addition, ArtCarved had its own operating and reserve accounts and administered its own payables, receivables and payroll.

By 1988, the ArtCarved subsidiary of Lenox had not been profitable. Pursuant to a corporate restructuring plan, Lenox decided to dispose of ArtCarved and all associated assets. Lenox liquidated ArtCarved by selling all of its assets. The sale of ArtCarved for $118,341,000 completed the cessation of Lenox's involvement in the sale and manufacture of fine jewelry. Lenox did not retain any of the ArtCarved liquidation proceeds for use in its ongoing business operation and, instead distributed all proceeds by wire transfer within twenty-four hours of their receipt to Lenox's sole shareholder, Brown-Foreman Corporation. Lenox has not reentered the jewelry business.

For tax purposes, the sale produced a $46,700,194 gain on which Lenox paid taxes in New Jersey. Lenox classified the gain as "nonbusiness income" on its North Carolina tax return for the fiscal year ending 1988, pursuant to N.C.G.S. § 105-130.4(a)(1) and (a)(5) of the North Carolina Corporate Income Tax Act, and therefore did not pay taxes on this gain. The North Carolina Department of Revenue (DOR), however, reclassified the gain as business income and assessed corporate income tax in the amount of $469,540, which Lenox paid under protest. Lenox then filed this tax refund action to recover on its claim of erroneous taxation.

In order to achieve uniform taxation among states, North Carolina modeled its Corporate Income Tax Act, N.C.G.S. ch. 105, art. 4, pt. 1 (1999), after the income classification scheme in the Uniform Division of Income for Tax Purposes Act (UDITPA). Polaroid Corp. v. Offerman, 349 N.C. 290, 294, 507 S.E.2d 284, 288 (1998),cert. denied, 526 U.S. 1098, 119 S.Ct. 1576, 143 L.Ed.2d 671 (1999). Under this uniform statute, the net income of a multistate corporation, such as Lenox, is divided into two classes for taxation purposes: (1) "business income," which is apportioned among all states in which the corporation transacts business, N.C.G.S. § 105-130.4(i); and (2) "nonbusiness income," which is allocated solely to the state most closely associated with the income-generating asset, N.C.G.S. § 105-130.4(h), which in the present case would be New Jersey. See Polaroid, 349 N.C. at 294,

507 S.E.2d at 288. The Act defines "business income" as follows:

(1) "Business income" means income arising from transactions and activity in the regular course of the corporation's trade or business and includes income from tangible and intangible property if the acquisition, management, and/or disposition of the property constitute integral parts of the corporation's regular trade or business operations.

....

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

N.C.G.S. § 105-130.4(a)(1), (5).

Recently, in a case of first impression, this Court attempted to clarify the scope of the statutory definition of business income. Polaroid, 349 N.C. 290, 507 S.E.2d 284. In Polaroid, this Court held that the plain language of the statute contains two separate and independent tests for determining taxable business income, namely the "transactional" test and the "functional" test. Id. at 301, 507 S.E.2d at 293. The "transactional" test, which is the first part of the statutory definition, focuses on "income arising from transactions and activity in the regular course of the corporation's trade or business." N.C.G.S. § 105-130.4(a)(1); accord Polaroid, 349 N.C. at 295,

507 S.E.2d at 289. The "functional" test, which is the second part of the statutory definition, alternatively focuses on "income from tangible and intangible property if the acquisition, management, and/or disposition of the property constitute integral parts of the corporation's regular trade or business operations." N.C.G.S. § 105-130.4(a)(1); accord Polaroid, 349 N.C. at 296,

507 S.E.2d at 289. If either test is satisfied, the income in question constitutes taxable business income. See Polaroid, 349 N.C. at 300,

507 S.E.2d at 292.

The transactional test looks to the particular transaction generating the income to determine whether that transaction was done in the ordinary and regular course of business. Id. at 295, 507 S.E.2d at 289. The frequency and regularity of similar transactions, the former practices of the business, and the taxpayer's subsequent use of the income are all central to this inquiry. Id. In the present case, both parties agree that the income from the sale of ArtCarved does not satisfy the transactional test.

The functional test, on the other hand, focuses on income generated by the corporation's acquisition, management and/or disposition of property that is essential to the corporation's business operations. Id. at 301, 507 S.E.2d at 292-93. In this regard, defendant contends that ArtCarved was an integral part of Lenox's regular manufacturing business and that its sales proceeds therefore satisfy the functional test. As such, defendant argues the income from the sale of ArtCarved is "business income" for which Lenox must be taxed in North Carolina. Plaintiff Lenox, however, responds that the sale and liquidation of ArtCarved marked the end of Lenox's involvement in the manufacture and sale of fine jewelry and that the sales proceeds are more properly classified as "nonbusiness income."

Therefore, the sole issue before this Court is whether the liquidation and cessation of a separate and distinct operating division of Lenox constitute "business income" under the functional test of the statutory definition set forth by the North Carolina Corporate Income Tax Act, N.C.G.S. ch. 105, art. 4, pt. 1. We conclude that the income produced by the sale of ArtCarved should be classified as nonbusiness income.

In the instant case, ArtCarved manufactured and sold fine jewelry as a division of Lenox. The transaction in question divested the whole subsidiary of ArtCarved from Lenox and was a complete liquidation as to ArtCarved and a partial liquidation as to Lenox. Following its disposition of Art-Carved, Lenox did not return to this particular line of business. Additionally, the proceeds of the sale were distributed to the sole shareholder and were not reinvested in the Lenox corporation. The sale of the assets and property that generated this income was not an ordinary event but was one of an extraordinary and infrequent nature.

In Polaroid, this Court stated that the extraordinary nature or infrequency of the transaction is irrelevant. Polaroid, 349 N.C. at 296,507 S.E.2d at 289 (citing Texaco-Cities Serv. Pipeline Co. v. McGaw, 182 Ill.2d 262, 269, 230 Ill.Dec. 991, 695 N.E.2d 481, 485 (1998)). We further stated that if the asset or property was integral to the corporation's regular trade or business, "income resulting from the acquisition, management, and/or disposition of [that asset] constitutes business income regardless of how that income is received." Id. at 306, 507 S.E.2d 284, 507 S.E.2d at 296. Based on this specific language from Polaroid, defendant contends that this Court must determine that the assets associated with ArtCarved were integral to Lenox's regular trade or business operations and must thereby conclude that the income generated from the sale of those assets must necessarily be classified as business income without further analysis. Defendant is correct that an application of the above language from Polaroid would result in such a determination, regardless of how that income is received and regardless of how extraordinary or infrequent the transaction.

The wording of these two sentences in Polaroid is a cause of confusion, and we hereby disavow these statements. The statements in Polaroid are in direct contravention of the functional test of our statute which requires that the "property constitute [an] integral part[ ] of the corporation's regular trade or business operations." N.C.G.S. § 105-130.4(a)(1) (emphasis added). The source of corporate income cannot be disregarded, as extraordinary or infrequent transactions may well fall outside a corporation's regular trade or business. Again, the focus must be on the asset or property that generated the income and its relationship to the corporation's regular trade or business. To use such overly broad language as we have just disavowed would render the statutory definition of "nonbusiness income" meaningless.

Resolution of the issue in this case therefore depends upon our statutory interpretation of business income, as defined by the functional test. N.C.G.S. § 105-130.4(a)(1). The principal goal of statutory construction is to accomplish the...