Case Title: Union Carbide Corp. v. Offerman

Citation: 351 N.C. 310

Docket Number: 453A98-2

State: north-carolina

Court: North Carolina Supreme Court

Date: 2000-02-04T00:00:00Z

Document:
IN THE SUPREME COURT OF NORTH CAROLINA
No. 453A98-2
UNION CARBIDE CORPORATION
v.
MURIEL K. OFFERMAN, Secretary of Revenue
Appeal pursuant to N.C.G.S. § 7A-30(2) from the decision of
a divided panel of the Court of Appeals, ___ N.C. App. __, 513
S.E.2d 341 (1999), after reconsideration in light of Polaroid
Corp. v. Offerman, 349 N.C. 290, 507 S.E.2d 284 (1998), cert.
denied, ___ U.S. ___, 143 L. Ed. 2d 671 (1999), affirming its
prior, unpublished decision, 130 N.C. App. 761, 508 S.E.2d 847
(1998), which affirmed in part, reversed in part, and remanded
summary judgment for plaintiff entered 5 May 1997 by Farmer, J.,
in Superior Court, Wake County.  Heard in the Supreme Court
12 October 1999. 
Alston & Bird LLP, by Jasper L. Cummings, Jr.; and Morrison
& Foerster, by Paul H. Frankel, pro hac vice, for plaintiff-
appellee.
Michael F. Easley, Attorney General, by Kay Linn Miller
Hobart, Assistant Attorney General, for defendant-appellant.
Multistate Tax Commission, by Paull Mines, General Counsel,
and Roxanne Bland, Counsel, amicus curiae.
Womble Carlyle Sandridge & Rice, P.L.L.C., by Samuel M.
Taylor, on behalf of Committee on State Taxation, amicus
curiae.
WAINWRIGHT, Justice.
Union Carbide Corporation (“Union Carbide”) is chartered
under the laws of the State of New York, having its principal
place of business in Danbury, Connecticut.  Union Carbide
manufactures and sells alloys, chemicals, industrial gases, and
plastics.  A portion of this business is administered in North
Carolina. 
Since 1951, Union Carbide has maintained and is the sponsor
of a pension plan for its employees.  This plan is a qualified
plan under the applicable Internal Revenue Code provisions.  See
26 U.S.C. § 401(a (1982 & Supp. 1985).  The pension plan defined
benefits to be received by Union Carbide employees upon
retirement and employed a trust fund from which all the
obligations would be paid.  Union Carbide funded the pension plan
through contributions from its general business earnings in
amounts based on the expected needs of the plan to meet its
obligations to its employees.
In 1984, there was a catastrophic gas leak at Union
Carbide’s facility in Bhopal, India.  As a result, Union
Carbide’s stock prices plummeted.  Union Carbide adopted a
restructuring plan in order to prevent a hostile takeover, which
could have resulted in significant layoffs.  The restructuring
plan consisted of “spinning off” excess funds from the pension
plan not needed to cover benefits for current employees,
purchasing annuities with the spun-off assets to pay benefits to
retired employees, and distributing the remainder to shareholders
to increase stock prices. 
In 1985, actuarial consultants for the pension plan
determined the plan was over funded because the trust’s assets
substantially exceeded the value of benefits earned by employees
covered by the plan.  The plan was over funded largely due to
superior investment decisions.  In situations where there is an
over-funded plan, the Internal Revenue Code allows excess pension
funds to be reverted to the plan sponsor, here Union Carbide.  26
C.F.R. § 1.401-2(b)(1) (1985).  In December 1985, Union Carbide
obtained the necessary authorization to cause a reversion of
excess funds from the pension plan. 
Union Carbide used a portion of the reverted funds to
purchase annuities to pay benefits to retired employees.  A
balance of five hundred million dollars of the funds reverted to
Union Carbide.  Union Carbide, on its 1985 federal tax return,
recognized the reverted funds as ordinary income for federal tax
purposes.  Union Carbide reported the reverted funds as
nonbusiness, nontaxable income on its 1985 corporate tax return
in North Carolina and allocated the reverted income entirely to
Connecticut, its state of domicile.
The North Carolina Department of Revenue (DOR) audited Union
Carbide’s corporate tax return and reclassified the reverted
funds as business income, apportionable to North Carolina
pursuant to N.C.G.S. § 105-130.4(i).  DOR’s tax assessment
included the tax owed plus interest and a penalty.  On 17
November 1992, Union Carbide paid DOR $243,114.14, and on 8 April
1996, Union Carbide paid DOR $517,115.35, for a total payment of
$760,229.49.  Thereafter, on 17 July 1996, Union Carbide filed
suit to obtain a refund of the taxes paid. 
Both Union Carbide and DOR moved for summary judgment in
Wake County Superior Court.  The trial court held there were no
genuine issues of material fact, granted Union Carbide’s motion
for summary judgment, and ordered DOR to pay plaintiff
$760,229.49 with interest from the dates of payment. 
DOR appealed to the Court of Appeals from the order granting
Union Carbide’s motion for summary judgment and denying DOR’s
motion for summary judgment.  In an unpublished opinion, the
Court of Appeals held, inter alia, the reverted funds were not
business income to Union Carbide under the “transactional test”
defined in Polaroid Corp. v. Offerman, 128 N.C. App. 422, 496
S.E.2d 399 (1998) (Polaroid I), because the reversion of excess
pension plan funds was not a part of Union Carbide’s regular
trade or business.  Union Carbide Corp. v. Offerman, 130 N.C.
App. 761, 508 S.E.2d 847 (1998) (Union Carbide I). 
This Court allowed review of Union Carbide I for the limited
purpose of remanding to the Court of Appeals for reconsideration
in light of Polaroid Corp. v. Offerman, 349 N.C. 290, 507 S.E.2d
284 (1998) (Polaroid II), cert. denied, ___ U.S. ___, 143 L. Ed.
2d 671 (1999), which identified a “transactional test” and a
“functional test” in the definition of “business income.”  Union
Carbide Corp. v. Offerman, 349 N.C. 534, ___ S.E.2d ___ (1998)
(Union Carbide II).
A brief review of the Polaroid case is instructive in the
instant case.  In Polaroid I, Polaroid Corporation (Polaroid)
collected a judgment against Eastman Kodak Corporation (Kodak)
for Kodak’s infringement of Polaroid’s patents.  Polaroid I, 128
N.C. App. at 423, 496 S.E.2d at 400.  Polaroid classified the
judgment proceeds as “nonbusiness income” for income tax
purposes.  Id.  DOR disagreed and reclassified the judgment
proceeds as “business income” taxable in North Carolina.  Id. 
Polaroid paid the assessment and filed suit to obtain a refund. 
Id.  The trial court granted summary judgment for DOR.  Id.
On appeal, the Court of Appeals reversed and ordered summary
judgment in favor of Polaroid.  The Court of Appeals based its
decision on the definition of “business income,” which provides: 
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.
N.C.G.S. § 105-130.4(a)(1) (1999) (emphasis added).  The Court of
Appeals held business income “aris[es] from transactions and
activity in the regular course of the corporation’s trade or
business” (the “transactional test”), while the phrase beginning
with “and includes” provides examples of what fits within the
definition.  Polaroid I, 128 N.C. App. at 424-25, 496 S.E.2d at
400-01.  Utilizing this interpretation, the Court of Appeals
ordered a refund for Polaroid.  Id. at 427, 496 S.E.2d at 402.  
On review of Polaroid I, this Court reversed the Court of
Appeals, holding the portion of the definition after the words
“and includes,” was a “functional test,” and was an additional,
distinct test for determining business income, as opposed to
examples of business income.  Polaroid II, 349 N.C. at 297-301,
507 S.E.2d at 290-93.  As a result, business income is now
classified according to the “transactional test” and the
“functional test.”
On remand, in the instant case, the Court of Appeals
addressed only the issue of whether the reverted funds are
business income or nonbusiness income under the two-prong test of
Polaroid II.  See Union Carbide Corp. v. Offerman, ___ N.C. App.
___, 513 S.E.2d 341 (1999) (Union Carbide III).  The Court of
Appeals unanimously held the reverted funds were not business
income under the “transactional test” because: (1) the reversion
of excess funds, not the operation of the pension plan, created
the income; (2) the removal of funds from the over-funded pension
plan was a rare and extraordinary event; and (3) no such removal
occurred before or since the reversion in 1985.  Id. at ___, 513
S.E.2d at 343.  A majority of the Court of Appeals also held any
income derived from the reverted funds was nonbusiness income
under the “functional test” defined in Polaroid II because: (1)
Union Carbide did not own any interest in the pension plan trust;
(2) the pension plan, while an aspect of a compensation package,
was not essential to Union Carbide’s chemical business; and (3)
Union Carbide did not rely on the employee pension plan to create
corporate income.  Id. at ___, 513 S.E.2d at 344.  The dissent
stated the income from the reverted funds was business income
under the functional test because: (1) the goal of attracting and
retaining qualified employees is clearly integral to the
successful operation of a business; (2) Union Carbide, in
deducting its contributions as “necessary business expenses,”
cannot later contend the pension plan was not necessary to its
business; (3) Union Carbide’s rights to withdraw excess funds and
to direct investments satisfy the “acquisition, management,
and/or disposition” portion of the functional test; and (4) this
result is not fundamentally unfair because Union Carbide deducted
the contributions from business income but then recaptured a
substantial portion of the funds and classified them as
nonbusiness income, with North Carolina seeking to tax only the
portion representing contacts within North Carolina.  Id. at ___,
513 S.E.2d at 345-46 (Horton, J., dissenting).
In DOR’s appeal as of right to this Court, our review is
limited to the sole issue presented which is whether the entire
reversion of pension plan contributions constitutes business
income under the “functional test” as first described in Polaroid
II. 
Following our discussion in Polaroid II, the instant case
is, in essence, a case of statutory construction.  It is well
settled that “‘[w]here the language of a statute is clear and
unambiguous, there is no room for judicial construction and the
courts must give [the statute] its plain and definite meaning,
and are without power to interpolate, or superimpose, provisions
and limitations not contained therein.’”  State v. Camp, 286 N.C.
148, 152, 209 S.E.2d 754, 756 (1974) (quoting 7 John M. Strong,
North Carolina Index 2d Statutes § 5 (1968)).  
An important function of statutory construction “is to
ensure accomplishment of the legislative intent.”  Polaroid II,
349 N.C. at 297, 507 S.E.2d at 290.  We first look to the words
chosen by the legislature and “if they are clear and unambiguous
within the context of the statute, they are to be given their
plain and ordinary meanings.”  Brown v. Flowe, 349 N.C. 520, 522,
507 S.E.2d 894, 896 (1998).  In Polaroid II, this Court analyzed
the plain language of N.C.G.S. § 105-130.4(a)(1) and concluded
the decision of the General Assembly to utilize different
language in the two clauses of the statute evidences its
intention to define business income with two distinct tests. 
Polaroid II, 349 N.C. at 298, 507 S.E.2d at 291.  Accordingly,
this Court held the plain language of N.C.G.S. § 105-130.4(a)(1)
provides for a “transactional test” and a “functional test” in
determining whether certain funds are business income.  Id. at
301, 507 S.E.2d at 293.
The 1985 version of N.C.G.S. § 105-130.4(a)(1) is identical
to the 1989 statute analyzed in Polaroid II.  Thus, as only the
application of the “functional test” is here on review, we
analyze the present fact situation under the “functional test”
described in Polaroid II.  
Under the “functional test,” business income “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.”  N.C.G.S. § 105-130.4(a)(1) (emphasis added).  
In analyzing the plain language of N.C.G.S. § 105-
130.4(a)(1), this Court in Polaroid II first noted “the phrase
‘acquisition, management, and/or disposition’ contemplates the
indicia of owning corporate property.’”  Polaroid II, 349 N.C. at
301, 507 S.E.2d at 292.  The pension plan in the instant case was
not Union Carbide’s property.  Union Carbide was the plan’s
sponsor, not its owner.  Therefore, Union Carbide did not
acquire, manage, and/or dispose of any corporate property.  Union
Carbide held only a contingent property right in the excess funds
in the event of a plan termination.
Additionally, in Polaroid II, we defined “integral” as
“‘essential to completeness.’”  Id.  (quoting Merriam-Webster’s
Collegiate Dictionary 607 (10th ed. 1993)).  In the instant case,
the contingent property right was not integral or essential to
Union Carbide’s business of making and selling alloys and
chemicals.  
Moreover, the phrase “regular trade or business operations”
refers to business operations done in a recurring manner, or at
fixed or uniform intervals.  See Merriam-Webster’s Collegiate
Dictionary 985 (10th ed. 1999).  In the instant case, the assets
of the pension plan were not used to generate income in the
regular business operations.  The assets were not working
capital.  The assets were not used as collateral in borrowing. 
The assets were not actively traded.  Finally, the assets were
not relied upon to purchase equipment or support research and
development.  Thus, the reversion of excess funds by Union
Carbide, a one-time occurrence, not a recurring event, was not
part of Union Carbide’s “regular trade or business operations.”
In sum, the assets were not essential to Union Carbide’s
regular trade or business operations.  The assets were merely
surplus investment assets which were not needed to meet the
obligations of the pension plan.  Thus, Union Carbide’s
contingent property right in the excess pension plan funds does
not meet the functional test of business income.  The plan funds
were not integral to Union Carbide’s regular trade or business
operations of making and selling alloys, chemicals, industrial
gases, and plastics.  The plan funds, which produced the income
at issue, functioned as an investment for the benefit of Union
Carbide employees.
As the reverted funds do not constitute business income
under the transactional test or the functional test, Union
Carbide properly classified the funds as nonbusiness income on
its North Carolina tax return.  The dissent below points out that
Union Carbide deducted its contributions as “necessary business
expenses,” thereby reducing the amount of business income subject
to state and federal taxation, and should not be able to regain a
substantial portion of the funds and claim they were not integral
to its business operations.  However, Union Carbide reported the
reverted excess funds as ordinary income on its federal tax
return and as taxable income on its Connecticut tax return, the
state of domicile.  The reverted funds are not business income,
but rather are investment income taxable by the domicile state. 
Moreover, whether or not the funds were classified as “necessary
business expenses,” they were not used “in the regular course of
the corporation’s trade or business” and were not “integral” to
“the corporation’s regular trade or business operations” in North
Carolina.  Therefore, Union Carbide did not have to pay income
tax on the reverted funds in North Carolina. 
If, assuming arguendo, the pension plan was Union Carbide’s
property, then the acquisition, management, and/or disposition of
the pension plan did not constitute an integral part of Union
Carbide’s regular trade or business operations.  While the plan
may have assisted Union Carbide in attracting more qualified
employees, the pension plan itself is not essential to Union
Carbide’s regular trade or business operations of producing
alloys and chemicals.  Moreover, while there exists a possibility
that some of the reverted funds consisted of principle which had
been deducted as business expenses by Union Carbide, rather than
merely gains on investment, we are limited to the matters of
record and are unable to apportion any unknown amounts.
Accordingly, under the plain language of the functional test
of N.C.G.S. § 105-130.4(a)(1), the reversion of excess pension
plan funds was not business income to Union Carbide.  For these
reasons, the decision of the Court of Appeals is 
AFFIRMED.
Justice MARTIN did not participate in the consideration or
decision of this case.
========================
Justice LAKE dissenting in part.
Although I concur with the majority’s opinion that
reverted pension funds resulting from gains on investment are
nonbusiness income, I do not agree that this conclusion should be
broadly extended to all pension fund reversion dollars.
In applying the “transactional test” or the “functional
test” in determining whether income is business or nonbusiness
income, it is important to establish the origin of the income. 
In its opinion, the majority states that Union Carbide’s plan was
over funded “largely due to superior investment decisions.”  It
is my opinion that to the extent the flow-back of the funds
resulted from an occurrence other than gains on investment, such
as corporate restructuring, pension plan restructuring or funding
in excess of the plan’s requirements, those dollars should be
“flowed back” to the state from which they had previously been
deducted as business expense, thereby decreasing taxable income
in that state.  A flow-back in this manner would not only allow
for the consistent treatment of dollars as “business expense”
when deducted and “business income” when flowed back, but would
ensure that corporations cannot manipulate their earnings by
redirecting reversion funds to a state with a lower state tax
rate.
In the instant case, it does not appear that all of
Union Carbide’s reversion funds resulted from gains on
investment.  Therefore, it is my opinion that the case should be
remanded for a determination, to the extent possible, of what
portion of the reversion resulted from gains on investment and
what portion resulted from a flow-back of previously deducted
business expense.  The portion previously deducted as business
expense in North Carolina should be flowed back to this state as
taxable income.
Justice FREEMAN joins in this dissenting opinion.