Pledger v. Getty Oil Exploration Co., 91-228
| Decision Date | 04 May 1992 |
| Docket Number | No. 91-228,91-228 |
| Citation | 831 S.W.2d 121,309 Ark. 257 |
| Parties | James PLEDGER, Director, Department of Finance and Administration, State of Arkansas, Appellant, v. GETTY OIL EXPLORATION COMPANY, Appellee. |
| Court | Arkansas Supreme Court |
Rick Pruett, Little Rock, for appellant.
Eugene G. Sayre, Little Rock, David J. Dziak, Tulsa, Ok., for appellee.
The single issue in this case is whether the accrued interest income of the appellee corporate taxpayer, Getty Oil Exploration Company, constituted apportionable business income in 1983 and 1984 under the Uniform Division of Income for Tax Purposes Act. The chancellor determined that the income was not taxable by the State of Arkansas. We affirm the chancellor's ruling.
Getty Oil Company, the taxpayer's parent corporation, was a publicly traded major integrated oil company which was incorporated in Delaware but had its headquarters and commercial domicile in Los Angeles, California. In 1979, in anticipation of a subsequent merger, Getty Oil Company formed a wholly owned domestic subsidiary, Getty Reserve Oil, Inc., which also was headquartered in Los Angeles. This subsidiary was authorized to do business in eighteen states, including Arkansas. At the same time, Reserve Oil and Gas Company was a major integrated oil and gas producer and marketer and was a parent company of numerous wholly owned subsidiaries, including Reserve Oil, Inc.
On January 23, 1980, Getty Oil Company acquired the Reserve Oil and Gas Company by corporate merger. The merger included the assets of the wholly owned subsidiary, Reserve Oil, Inc. The assets of Reserve Oil, Inc. were transferred, as planned, to Getty Reserve Oil, Inc. None of the assets of Reserve Oil, Inc. were shown to be in Arkansas. Reserve Oil, Inc. was subsequently dissolved and is no longer material to this case. Getty Reserve Oil, Inc. soon transferred the assets it received from Reserve Oil, Inc. to its parent, Getty Oil Company for a consideration of $159,750,000.00. Getty Oil Company paid this amount with a promissory note dated August 1, 1980, payable to Getty Reserve Oil, Inc. and bearing interest at the rate of six (6) per cent. (It is the interest on this note that will accrue in 1983 and 1984 which the Department of Finance and Administration will attempt to tax.) Getty Oil Company never made a cash payment on the note and for the first sixteen months, made no entries reflecting interest owing on the note. Likewise, Getty Reserve Oil, Inc. made no entries showing interest accruing on the note. Next, on December 31, 1982, immediately before the tax years at issue began, the books of Getty Reserve Oil, Inc. reflected an accrual of $24,247,189.42 interest income on the note and the records of Getty Oil Company reflected the same as an accrued interest expense.
After the note had been executed and delivered, Getty Reserve Oil, Inc. conducted an active oil and gas exploration business in eighteen states and, as a part of that business, acquired and managed gas producing properties in Arkansas.
In early 1983, Getty Oil Company negotiated the sale of Getty Reserve Oil, Inc.'s corporate stock to an unrelated company, Comajo Petroleum Company. However, Getty Oil Company wanted to keep the Arkansas gas producing properties and negotiated retention of those assets.
Meanwhile, from August 10, 1972, until December 28, 1982, Getty Oil Company owned an inactive subsidiary named Getty Oil International (Spain) S.A. On December 28, 1982, the name of this subsidiary was changed to Getty Oil Exploration Company. On February 11, 1983, Getty Oil Exploration Company became qualified to do business in Arkansas under the name of Getty Arkoma, Inc., and immediately afterwards, the promissory note and the title to the Arkansas gas producing properties were transferred from Getty Reserve Oil, Inc. to Getty Oil Exploration Company. (The State contends that the income tax liability began to accrue at this time to Getty Oil Exploration Company.) Getty Oil Exploration Company had no employees of its own; it contracted with Getty Oil Company for the active management of the Arkansas gas fields. It did not hold the note; it was held in Getty Oil Company's office. Getty Oil Exploration Company did not control the note; it was controlled by Getty Oil Company's corporate treasury department. Getty Oil Exploration Company gave nothing for the note which was later cancelled under generally accepted accounting principles.
On December 31, 1983, Getty Oil Company issued a new promissory note to Getty Oil Exploration Company in the amount of $204,793,434.14 bearing interest at the rate of eleven (11) per cent. This new note represented a consolidation of all indebtedness between the parent and the subsidiary. Getty Oil Exploration Company's books, which were kept by the corporate treasury department of Getty Oil Company, reflected an intercompany interest income of $23,211,877.00 as of December 31, 1984. This interest was classified on the corporate books as non-operating revenue. On December 31, 1984, the trial balance of Getty Oil Exploration Company books showed accrued intercompany interest receivable of $11,979,097.00 and long-term intercompany notes receivable of $216,026,213.00.
On February 17, 1984, Texaco, Inc. acquired all of the stock of Getty Oil Company and all of its subsidiaries. As part of the plan of reorganization of the merged companies, Texaco, Inc. made Getty Oil Company a wholly owned subsidiary. Texaco, Inc. owned another subsidiary, Texaco Producing, Inc., and it caused Texaco Producing, Inc. to acquire all of the stock of Getty Oil Exploration Company. By the end of 1984, Getty Oil Company had transferred most of its assets and liabilities, including the liability on the note at issue, to Texaco Producing, Inc. in exchange for stock in Texaco Producing, Inc. In 1985, Texaco, Inc. caused Getty Oil Exploration Company to transfer all of its assets, including the promissory note and title to the gas properties in Arkansas, to Texaco Producing, Inc. as a dividend in kind. Thus, Texaco Producing, Inc. held both the liability of the note payable and asset of the note receivable. The asset and the liability were then canceled by offsetting accounting entries on the books of Texaco Producing, Inc. Under generally accepted accounting principles, when an obligation and an asset are in the same company, it is the accepted practice to cancel the note.
In Arkansas, Getty Oil Company filed a separate income tax return in 1983 and filed an apportioned income tax return in 1984. It did not attempt to deduct the interest accruing to Getty Oil Exploration Company on either of these returns. Getty Oil Exploration Company, the taxpayer, filed an apportioned tax return in both 1983 and 1984, and reported the accrued interest income, but designated it as "nonbusiness income." Therefore, it did not pay income tax to the State of Arkansas on the accrued interest income.
Through auditors, the Director of the Department of Finance and Administration conducted an audit of Getty Oil Exploration Company's 1983 and 1984 income tax returns and reclassified the accrued interest as "business income." This reclassification caused Getty Oil Exploration's gross income to be increased in 1983 from $1,838,208.00 to $22,638,083.00 and in 1984 from $1,063,283.00 to $21,372,622.00, and caused a deficiency assessment of $389,433.00. Getty Oil Exploration Company protested the deficiency assessment, but it was affirmed by the Administrative Law Judge of the Revenue Department's Board of Hearings and Appeals. The Commissioner of Revenues denied a request for a revision. In 1987, an assessment of corporate income tax and interest was made against Getty Oil Exploration Company in the amount of $512,065.18. This amount was paid by Texaco, Inc., under protest, and this suit for refund was filed in the Chancery Court of Pulaski County. The chancellor found that the accrued interest was "nonbusiness income" and entered a judgment in favor of the taxpayer for the amount paid under protest.
The Director of Finance and Administration's single point of appeal is that the accrued interest was "business income" and therefore taxable. The...
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