This case is before the court on Plaintiffs' Motion for Summary Judgment or Partial Summary Adjudication of Issues and Defendant Department's Cross-Motion for Summary Judgment and Response to Plaintiffs' Motion for Summary Judgment or Partial Summary Adjudication of Issues. This is the second round of such motions in this
The facts relevant to this order are, for the most part, stated in the prior opinion of this court. They include the facts relating to the acquisition and development of the FCC license.
In addition to the facts summarized in the earlier opinion, the record reveals that the market value of the FCC license was a function of how many customers had been developed for the area covered by the license. Taxpayers engaged in no other activities other than those associated with the development, operation, and disposition of the FCC license and related assets.
The first issue presented for decision is whether the gain from the disposition of the FCC license was business income or nonbusiness income for purposes of applying the apportionment and allocation provisions of ORS 314.280.
Assuming the income produced was business income, the second issue presented by the parties is what are the income-producing activities associated with the gain on disposition of the FCC license, and particularly are those income producing activities limited to activities undertaken by the employee of Crystal in negotiating for and completing the transaction by which the FCC license was sold?
The proper resolution of the current round of this income tax case involves consideration of ORS 314.280, ORS
This period begins with the adoption of personal and corporate net income tax statutes in 1929. Or Laws 1929, ch 448 (corporate income); Or Laws 1929, ch 427 (personal income). From 1929 to 1965, the statutory principles of apportionment that applied to corporations and nonresident individuals were essentially stable and, as of 1957, may be described as follows:
The "legislative" rules that the department promulgated under ORS 314.280 remained basically stable from 1929 to 1965 and, as of 1965, had the following features.
It follows that on the eve of the adoption of Oregon UDITPA, the gain on the sale of the FCC license would unquestionably have been subjected to taxation in Oregon on an apportioned basis. The FCC license would obviously and undeniably have been considered "a part of or connected with the unitary business" and therefore, as described in factor (e)(i) above, would have been income subject to apportionment. See Reg. 314.280(1)-(B) (1964). Even if the segregated method of accounting had been applicable, the FCC license would have been viewed as employed as a capital or current asset within Oregon — indeed, that is the only
Such a result would have been fully consistent with the underlying principles of the then applicable Oregon law — to subject to taxation income from whatever source derived, subject only to limitations imposed by Oregon statute or federal law. For individuals, that scope of inclusion of income was found in the provisions of ORS 316.125 (1963), ORS 316.105 (1963), ORS 316.015 (1963), and related rules. Those statutes and rules subjected to tax as gross income, income from any source, except as specifically exempted by law. Reg. 316.105(1)-(A) (1964). Specific exemptions were addressed in Regulation 316.110 (1964). Those included exemptions granted by statute and "those items of income exempted by federal constitutional law." ORS 316.110 (1963); ORS 316.305 (1963); Reg. 316.110 (1964).
For corporations, ORS 317.105 (1963) similarly stated the broadest definition of gross income as being income from any source. Although there was not an explicit provision acknowledging exemption based on constitutional limitations similar to that in Regulation 316.110 (1964), Regulation 317.000 (1964) made provisions of the personal tax regulations, such as Regulation 316.110 (1964), applicable to parallel sections of the corporate rules. Of course, even without such recognition, the federal constitutional limitations would have applied. And, except for Oregon statutory exclusions or exemptions, nothing indicated a legislative intent to subject to taxation less than was allowed under the federal constitution in the case of business operations in Oregon.
As to the constitutional limitations on the fiscal reach of Oregon law, the federal constitutional limits had
To summarize, on the eve of the adoption of Oregon UDITPA, the gain in question here would have been considered income from an asset connected to and part of a unitary business carried on in Oregon. As such, the gain would have been subject to tax in Oregon on an apportioned basis as determined under ORS 314.280 (1963).
The question then becomes what, if any, change in analysis or result is required or justified by the adoption of Oregon UDITPA? To that question, the court now turns.
To begin with, the adoption of Oregon UDITPA did not repeal, or alter in any material way, the apportionment provisions of ORS 314.280. See Or Laws 1965, ch 152, § 22. Certain taxpayers were excluded from the coverage of ORS 314.280. However, that statute remained effective for certain taxpayers, including, as the parties have agreed, those present in this case. (Ptfs' Ltr, Mar 3, 2009.) For such taxpayers, nothing in the reach of the tax imposition statutes and ORS 314.280 — to constitutional boundaries subject only to exclusion or exemption by an act of the Oregon legislature — was changed. There was no change in the basic statutory goals of ORS 314.280 — fair and accurate reflection of net income of business done within this state based on business activity in the state. Nor was there a change to the delegation made to the department to govern, by rule, fair and accurate reflection of business done within the state. The
The post-UDITPA rules of the department under ORS 314.280 and applicable in this case operate generally by incorporation.
In applying the teaching of Fisher, it does not matter that the language incorporated into the department rules under ORS 314.280 comes from other statutes as opposed to other department rules. The reference in OAR 150-314.280-(B) to ORS 314.610 stands no better than the reference to related rules under ORS 314.610. The language referred to must be measured against ORS 314.280 standards. See Fisher, 321 Or at 358-59. Were it otherwise, the department could avoid the teaching of Fisher too easily — it could simply refer to
The question becomes whether, following the adoption of UDITPA, the incorporation of language from ORS 314.610 and OAR 150-314.610(1)-(B) should be construed as changing in any way the results that would have been obtained under the rules in effect on the eve of the adoption of UDITPA. In short, is OAR 150-314.610(1)-(B) properly construed under ORS 314.280 as making the gain present in this case subject to tax, on an apportioned basis, as it would have been subject before 1965, or does that language work a different result?
The answer to the foregoing question is not difficult. OAR 150-314.610(1)-(B)(2) states:
(Emphasis added.) The "was used in" test of the rule defining "business income" is essentially no different from the "part of or connected with a unitary business" test that had been the rule prior to 1965 under Regulation 314.280(1)-(B) (1964) in defining "apportionment income." Further, as mentioned above, little change occurred in 1965 to ORS 314.280.
The court concludes that the department had the authority to, and did, properly incorporate, for use under ORS 314.280, the language from OAR 150-314.610(1)-(B), making gain on sale of assets used in a business subject
To construe the provisions of OAR 150-314.610(1)-(B), under ORS 314.280 principles, in any other way would be to work a radical change in taxation of persons subject to ORS 314.280 when no statutory or other authority exists for such a conclusion.
The assessment of the department was proper.
Taxpayers have argued that principles of Oregon UDITPA should be used in construing OAR 150-314.610(1)-(B) even when it is being applied by incorporation under ORS 314.280. As stated above, the court rejects this methodology, but, for the reasons that follow, no different outcome would occur in any event. In construing OAR 150-314.610(1)-(B) against, or in the context of, only ORS 314.610, it is appropriate to consider:
The existence, under ORS 314.610, of a "functional test" separate from the so-called "transactional test" has been definitively settled by our Supreme Court. In Pennzoil Co. and Subsidiaries v. Department of Revenue (Pennzoil), the Supreme Court stated: "[T]his court has recognized that ORS 314.610(1) has two parts * * *. Each part involves a separate test: part one requires a `transactional test' and part two requires a `functional test.'" 332 Or. 542, 546, 33 P.3d 314 (2001), cert den, 535 U.S. 927, 122 S.Ct. 1297, 152 L Ed 210 (2002) (quoting Willamette Industries, Inc. v. Dept. of Rev., 331 Or. 311, 316, 15 P.3d 18 (2000) (Willamette Industries) and Simpson Timber Company v. Dept. of Rev., 326 Or. 370, 374, 953 P.2d 366 (1998) (Simpson)).
Does the functional test of "business income" include gain on any sale of business related assets or only sales that are a "regular" part of a business? The focus of this analysis is on the statutory phrase "and includes income from tangible and intangible property if the acquisition, the management, use or rental, and the disposition of the property constitute integral parts of the taxpayer's regular trade or business operations." ORS 314.610(1). There is no question that the assets in question here were acquired, managed, and used as integral parts of taxpayers' business. For the gain on the assets to be business income, must the disposition be an integral part of taxpayers' regular business operations, and was it? The analysis here will address (a) the need for a separate role for this functional test, (b) the concept of property that is integral to business operations, and (c) the scope of change effected by the adoption of Oregon UDITPA.
The parties have nicely set out what have become the widely articulated arguments both as to the existence of a separate functional test under ORS 314.610(1) and whether or when gain from dispositions of assets used in a business are business income. Those arguments are set out in the briefs and are also found in Jerome R. Hellerstein and Walter Hellerstein, 1 State Taxation ¶ 9.05 (3d ed 2010).
Suffice it to say that the courts of other states are split on this issue. Some read the "and" in a mandatory conjunctive fashion and consider occasional sales of property used in a business as nonbusiness income. See Pennzoil, 332 Or at 547 (citing with approval Hoechst Celanese Corp. v. Franchise Tax Bd., 25 Cal.4th 508, 22 P.3d 324, cert den, 534 U.S. 1040, 122 S.Ct. 614, 151 L Ed 537 (2001)). The highest court of California, a state bearing an important relationship to the development of the law of unitary taxation and on whose courts Oregon courts have often relied, finds the functional test to exist and to apply to dispositions of property used in a business. See Hoechst Celanese Corp., 22 P3d at 332, 334.
Taxpayers here maintain that for gain on disposition to be business income under the functional test, the disposition must have been a regular part of the business of the taxpayer. This court is of the view that because the Oregon Supreme Court has recognized the existence of a functional test, the position of taxpayers must be rejected. See Pennzoil, 332 Or at 546.
Taxpayers' construction has the effect of rendering the functional test, recognized by our Supreme Court as an independent test, as completely redundant or duplicative of the "transactional test." If each of the acts of "acquisition," "management," "use" or "rental," and "disposition" must be regularly undertaken in connection with any given asset, those activities will necessarily also, in all cases, constitute "transactions * * * in the regular course of the taxpayers' trade or business," and therefore be covered by the "transactional test." See ORS 314.610(1); Pennzoil, 332 Or at 547.
That exclusion would be a dramatic departure from the pre-1965 rule that Oregon's tax reach under apportionment principles extended to the federal constitutional boundaries. Recall that under Fargo, the United States Supreme Court restricted the reach of the unitary principle, but it recognized that a state where an asset is used in business has a claim to tax when the asset is connected to — integral to — the business. 193 US at 499-500. That principle focuses on the asset and not on the context of its disposition. See id.
There is no indication that anyone believed such major changes in apportionment had been effected by the adoption of Oregon UDITPA. Representative James A. Redden said so in the debate on the floor of the House of Representatives:
Testimony, House Floor Debate, HB 1003, Feb 16, 1965, Tape 7, Side 2 (statement of Rep James Redden).
Further, our Supreme Court reached a similar conclusion in Sperry and Hutchinson v. Department of Revenue, 270 Or. 329, 527 P.2d 729 (1974) (S&H). There, speaking about
S&H, 270 Or at 331-32 (emphasis added; footnote omitted). The court in S&H in places wrote as if it was construing the transactional test — is the income or gain from transactions arising in the regular course of business? See id. at 331-34. However, the quoted language shows the court was concerned with the relationship of the asset to the business.
It is simply not possible to read this contemporaneous judicial analysis and the comments of Representative Redden with meaning and yet also conclude that the intent of the legislature in adoption of Oregon UDITPA was to, for the first time, exclude major items of income from apportionable income by means of the definition of "business income." For all of the foregoing reasons, the court concludes that one sale of an asset that has been an integral part of a business constitutes "business" income under ORS 314.610.
The existing case law neither requires nor supports a different conclusion as to how to read the elements of the functional test. As already mentioned, S&H was decided just after the adoption of Oregon UDITPA and addressed tax years both before and after the enactment of Oregon UDITPA. 270 Or at 332-33. The question was the apportionability of income from three different groups of intangibles: long-term investments, short-term investments held pending developments in the market for other long-term investments, and short-term investments held to satisfy working
As to all investments and all years at issue, the court examined whether the investment or earnings were "part of the trading stamp business." Id. at 332. Although the court looked at the statutory language that contains the "transactional test," the opinion begins with the language quoted above and ends with the observation that income will not be apportionable if the taxpayer shows the intangibles "were not used in or held for use in its trading stamp business." Id. at 334. If a test of "part of the business" or a test of "used in or held for use in the business" is applied to taxpayers in this case, the gain from sale of the license is clearly apportionable business income.
In Simpson, the question was whether interest on a condemnation award was apportionable income.
Although Justice Durham, in concurrence, concluded that the disposition element of the functional test requires that disposition of an asset also be integral to the business, the majority opinion did not require that the
Willamette Industries, the next case of relevance, does not purport to depart from the analysis of the functional test described in Simpson. See 331 Or at 318. Describing its actions in Simpson regarding the fundamental test, the Willamette Industries court quoted the following language from Simpson:
Id. (quoting Simpson, 326 Or at 376-77 (emphasis added)). Throughout the opinion in Willamette Industries, the court also showed that, as to the functional test, it was focused on the word "integral," placing emphasis on that word in its quote of ORS 314.610. See id. at 314-16. This shows the court was concerned with the department's rule OAR 150-314.610(1)-(B)(1) that rents and royalties are business income if the property producing the income is incidental to the business. See id.
In rejecting the department's rule and arguments regarding property incidentally related to a business, the court insisted on the statutory requirement that property be integrally related to a business if income or gain therefrom is to be business income. Id. at 315-16. The court recognized that the functional test uses a conjunctive phrase, quoting the statute with emphasis added as: "acquisition,
Id. at 319. The foregoing shows that where, as here, there is a disposition, the business income inquiry will focus on the relationship of the asset disposed of to the business of the taxpayer.
The conclusion reached in Willamette Industries is consistent with OAR 150-314.665(4). The taxpayer in Willamette Industries was a forest products company. See 331 Or at 313. Under certain of its timberlands, it held oil and gas rights. Id. Disposition of those rights was made in consideration of royalty payments. Id. The question was whether the oil and gas royalties were business income. Id. The taxpayer was not an oil and gas firm. Id. It had oil and gas interests underlying its timberlands because of the coincidence of property rules and not because those interests were integral to the wood products business carried on in Oregon. See id. at 313, 318. Further, the oil and gas interests were located outside of Oregon. Id. at 313. Accordingly,
The importance of these facts is found or reflected in the court's statement in Willamette Industries that:
331 Or at 319 (emphasis added). The disposition of minerals was certainly regular for Willamette Industries. It occurred regularly, as oil and gas was recovered, and produced royalty income as disposition of minerals occurred. But something more was needed. That was a relationship of the minerals to the "regular business operations of harvesting timber." Id. (emphasis added).
The logic of Simpson and Willamette Industries, taken together, is clear:
Taking this language from Simpson, quoted with favor by the court in Willamette Industries and by paraphrasing and
See Willamette Industries, 331 Or at 318 (quoting Simpson, 326 Or at 376-77) (emphasis in original omitted). This exercise demonstrates that under both Simpson and Willamette Industries, the functional test is satisfied as to gain from the disposition of the FCC license.
If regular dispositions do not need to be present to satisfy the functional test, as shown by Simpson, the question becomes whether there is any reason the functional test cannot be met when a disposition of an asset constituting an integral part of a business is one made at the conclusion of a particular taxpayer's business use of the asset. It bears remembering that the subject of the disposition in this case is an asset that is not only integral, but essential, to the business. The asset is even more business-related than the one of many stands of timber disposed of in Simpson. It also bears remembering that the record here discloses that taxpayers had clear expectations of harvesting gain from business operations by disposing of the assets to a third party.
None of S&H, Simpson, or Willamette Industries answer this question as none involved liquidation sales. However, each of these cases places more importance on the relationship of the asset to the business than on facts of the disposition. Under that approach, the answer is clearly that the functional test is satisfied.
No Oregon case addresses the liquidation sale issue, but the case law consistently addresses the relationship of the asset to the business, and particularly as to the relationship to business conducted in Oregon. See e.g., Simpson,
Considering the separate existence of a functional test, the need for a meaningful role for such a test, and the indication that the legislature intended no radical shift in apportionment rules when it adopted Oregon UDITPA, the taxpayers' construction of ORS 314.610(1) must be rejected. OAR 314.610(1)-(B), to the extent it is directly applicable to this case, is valid and leads to the conclusion that regular sales of property such as the license are not needed in order for gain from any given sale to be treated as apportionable business income where the asset was an integral part of the business.
The foregoing conclusion is supported by certain additional points. First, a construction of the department's rules that did not include gain from disposition of the FCC license in "business income" would create a fundamentally illogical and inequitable result. First, consider that the sale of business assets often involves, and obviously involved here, the sale of the future capacity of the asset to produce income, alone or in conjunction with the use of other assets. The license was continued in use by the buyer. Indeed, the pricing of business assets almost always reflects to some extent the present value of future income. In this case, the
Now consider the tax treatment of the asset sold in the hands of a "nonresident" purchaser of a license of the type involved here. That purchaser may claim amortization deductions calculated on the full purchase price of the license, including any amount of price associated with gain produced for the seller.
Rather, certainly as to assets in respect of which cost recovery deductions are permitted to a purchaser, such
To the extent the business asset is sold for more than its basis, as adjusted downward by prior cost recovery deductions, the gain reflects the fact that some portion of the asset was not used up in the seller's business, even though a cost recovery deduction was allowed as though it had been used up. Such a "true-up" is appropriate and indeed is found in the parallel federal tax concept of depreciation recapture. See e.g., IRC § 1245. Further, to the extent the seller who has used an asset in business is able to sell the asset for even more than that seller's original purchase price, that increment of gain is a reflection of an appreciation in the asset while held, maintained, and used in the selling of taxpayer's business. At a minimum, it is an increment of gain that accrued while the asset was held by the seller in its business. These consequences in the case of business assets that could produce deductions, weigh heavily against the treatment of gain as nonbusiness income.
ORS 314.280 and Oregon UDITPA are tools to be employed in a larger context of taxation by Oregon. They cannot extend the fiscal reach of the state beyond federal constitutional limits, but neither should they be read to frustrate the "reach" of overall tax policy of the state by restricting it more than the federal constitution requires — at least absent clear legislative intent to restrict reach.
The statutory reference to jurisdiction to tax can only mean the federal statutory or constitutional limitations applicable to Oregon.
As was discussed in the first order issued in this matter, Crystal I, the individual nonresident shareholders of Crystal, a subchapter S corporation, are considered the taxpayers. The character of their income is determined as if they each realized the item of income from the source from which was realized by Crystal as an S corporation. See ORS 314.734(2). This statutory mandate requires consideration of rules on source of income for nonresident individuals. ORS 316.127 provides such rules. As to intangible property such as the license, ORS 316.127(3) provides:
(Emphasis added.) As can be seen, gain on the disposition of intangible property is considered as derived by a nonresident from Oregon sources to the extent the property is employed in a business in Oregon. Id. Applying that test, the gain on the sale of the FCC license would clearly be Oregon source income, and taxable in Oregon, because the license is property employed in a business in Oregon. See id. Indeed, the license neither was nor could have been employed in any other state.
Note that if the provisions of ORS 314.605 to 314.675 (which are Oregon UDITPA), particularly the provision of ORS 314.610, are interpreted as taxpayers urge, a gain from the disposition of an intangible employed in a business carried on in this state would not be considered, to any extent, Oregon source income, but would rather be allocated to the state of commercial domicile. Accordingly, a contradiction would be created between ORS 316.127(3) and ORS 316.127(6).
This contradiction between ORS 316.127(3) and such a reading of ORS 316.610 as incorporated into ORS 316.127(6) can be avoided nicely by simply construing the functional test to the provision in OAR 150-314.610(1)-(B)(2) such that gain from the sale of an intangible asset used in the business is business income. Such a construction is consistent with the fact, discussed at the beginning of this order, that prior to the adoption of Oregon UDITPA, employment of intangible property in Oregon led to taxation, on an apportioned basis, of income or gain from the intangible. This construction comports with the fact that neither the legislature nor the courts have considered the adoption of Oregon UDITPA to have worked major changes in Oregon tax law.
Given the conclusion that the gain from the disposition of the assets of Crystal is business income, that gain is subject to apportionment. To accomplish this, a "sales factor" must be developed. The parties are at odds over the proper sales factor in respect of the sale of the FCC license. For this purpose, a particular rule applies to income from sales of property other than tangible personal property. OAR 150-314.280-(F);
The parties appear to have requested the court to decide whether gain from the sale of the license is includable in the numerator of an Oregon sales factor. As a preliminary matter, the court concludes that the gain should be included in the numerator and denominator of the Oregon sales factor pursuant to OAR 150-314.665(1)-(A). The business income at issue here can be readily attributed to a particular income-producing activity of the taxpayers. That activity is composed of the "transactions and activity directly engaged in by the taxpayer in the regular course of its trade or business for the ultimate purpose of obtaining gains or profit." OAR 150-314.665(4)(2)(emphasis added).
Here, those transactions and activity were the development, operation, and sale of the cellular network in the license area. The record shows activity was engaged in by taxpayers with the ultimate purpose of either obtaining profit from continued operation or gain from disposition of the license. The sale of the license was a step in realization of the ultimate purpose of obtaining an item of income, namely the gain on sale.
Taxpayers have suggested that the only activities to be considered in determining the numerator of the Oregon sales factor should be those associated with negotiation and
Looking at the item of income in question here, the gain from the sale of the license, that gain was produced by a combination of activities. The first element was activity related to building out the network and development of a customer base. The second element was value realization activity, including negotiation for and sale of the license and other assets. The costs of engaging in these activities and the proportion of the income-producing activity occurring in Oregon have not been stipulated and must be determined by further proceedings.
Now, therefore,
IT IS ORDERED that Plaintiffs' Motion for Summary Judgment is denied; and
IT IS FURTHER ORDERED that Defendant's Cross-Motion for Summary Judgment is granted; and
IT IS FURTHER ORDERED that this case is continued for further proceedings.
Unless otherwise noted, all references to the Oregon Revised Statutes (ORS) are to the 1999 edition.
Hereinafter, the State Tax Commission Regulations are referred to as Regulations, with the citation form of "Reg." The State Tax Commission Regulations can be found at Oregon State Archives.
Unless otherwise noted, all references to the Oregon Administrative Rules (OAR) are to the 1999 edition.