Phillips Petroleum Co. v. Iowa Dept. of Revenue and Finance

• Decision Date: 22 December 1993
• Docket Number: No. 92-1824,92-1824
• Parties: PHILLIPS PETROLEUM COMPANY, Appellant, v. IOWA DEPARTMENT OF REVENUE AND FINANCE, Appellee.
• Court: Iowa Supreme Court

Page 608

511 N.W.2d 608

PHILLIPS PETROLEUM COMPANY, Appellant, v. IOWA DEPARTMENT OF REVENUE AND FINANCE, Appellee.

No. 92-1824.

Supreme Court of Iowa.

Dec. 22, 1993.

As Corrected Dec. 28, 1993.

As Amended on Denial of Rehearing Feb. 17, 1994.

Glenn L. Smith of Finley, Alt, Smith, Scharnberg & May, P.C., Des Moines, Walter Hellerstein and Paul Frankel of Morrison & Foerster, New York City, and Larry Montanye of Phillips Petroleum Co., Bartlesville, OK, for appellant.

Bonnie J. Campbell, Atty. Gen., Harry M. Griger, Sp. Asst. Atty. Gen., and Valencia Voyd McCown, Asst. Atty. Gen., for appellee.

Considered by HARRIS, P.J., and LAVORATO, NEUMAN, SNELL, and ANDREASEN, JJ.

HARRIS, Justice.

Threatened with a hostile takeover, the management of a petroleum corporation responded by purchasing a substantial amount of its outstanding common stock. In order to retire the debt incurred for this purchase, the corporation sold gas and oil-producing assets, none of which were located in Iowa. The question in this case is whether the sale of those assets can be taxed by Iowa as business income of the corporation. The trial court determined it can be, thereby enabling Iowa to include the income taxes derived from the sales in its apportionment formula. We reverse.

The case was submitted on stipulated facts. Phillips Petroleum Corporation (Phillips) is a Delaware corporation domiciled in Oklahoma. It is engaged in various aspects of the oil and gas business including production, refining, and marketing. Phillips' only activities in Iowa consisted of marketing.

In December of 1984, Mesa Partners acquired 5.8 percent of Phillips common stock and announced plans to commence a tender offer to purchase up to an additional fifteen percent of the shares. Later, in February of 1985, Ichan Capital Corp. offered to purchase all the outstanding stock from Phillips with cash and subordinated debt. The stated purpose of these activities was to take control of Phillips.

In an effort to stave off these hostile takeover attempts, Phillips offered to exchange debt securities with an aggregate face value of $4.5 billion for roughly forty percent of its outstanding stock. As part of this repurchase plan, Phillips intended to raise $2 billion from the future sale of assets which would be used to retire a portion of the debt acquired in the exchange. The exchange occurred in March of 1985, decreasing the number of outstanding shares by fifty percent and reducing the probability of a hostile takeover.

As contemplated in the exchange offer, Phillips undertook a "special asset disposition program" for the sole purpose of raising cash to pay off the newly acquired debt. Under this plan Phillips and its subsidiaries sold approximately $2 billion in assets. The disposed assets consisted primarily of oil and gas reserves and related assets that had been purchased with capital derived from Phillips' business operations. They were intended to and did produce business income while owned by Phillips. Although Phillips occasionally sells this type of asset, no previous sale approached the magnitude of the disposition here. ¹

Initially Phillips paid Iowa taxes in accordance with the apportionment formula. Then, in November of 1988, Phillips filed amended tax returns with the Iowa department of revenue and finance (department) seeking a refund of taxes paid during the period when the disposition occurred. In May of 1989 the department denied a portion of the refund on the ground that Phillips' gain from the disposition gave rise to apportionable business income, rather than nonbusiness income, and was therefore taxable. Phillips proceeded to exhaust administrative remedies and sought judicial review in district court. The matter is before us on Phillips' appeal from a district court decision affirming the agency action.

Upon judicial review of final agency action we, like the district court, function in appellate capacity to correct errors of law. Iowa Code § 17A.19(8); Northwestern Bell Tel. Co. v. Iowa State Commerce Comm'n, 359 N.W.2d 491, 495 (Iowa 1984). Because the case was submitted on stipulated facts our review is on error.

I. The parties present the dispute as one of pure statutory construction. It involves Iowa Code section 422.32(2) (1993), which provides:

"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.

The statute must be understood in the light of its purpose. The commerce clause of the federal Constitution allows states to tax income of foreign corporations doing business within its borders. Cases interpreting the commerce clause allow taxation of income derived from the corporation's activities beyond the state's borders only in accordance with the "unitary-business principle." Under that principle the state may tax a portion of income derived elsewhere only if the activities were related to the corporate business activities within the state. Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U.S ----, ----, 112 S.Ct. 2251, ----, 119 L.Ed.2d 533, 547 (1992); Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 439-40, 100 S.Ct. 1223, 1232-33, 63 L.Ed.2d 510, 522 (1980). So long as states comply with these metes and bounds they are free to adopt their own scheme for taxing income of foreign corporations doing business locally.

Because of the problems inherent in accommodating various schemes, a number of states have adopted the uniform division of income for tax purposes act (UDITPA). See Asarco, Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 310, 102 S.Ct. 3103, 3105, 73 L.Ed.2d 787, 791 (1982). Iowa adopted it verbatim in 1979 as present Iowa Code section 422.32(2). See 1978 Iowa Acts ch. 1141, § 1.

The present dispute comes down to whether, as the department contends, the statute provides for two tests, one transactional and one functional. Phillips contends the...