Case Title: Harsco Corp. v. Tracy

Citation: 1999-Ohio-396

Docket Number: 19972006

State: ohio

Court: Ohio Supreme Court

Date: 1999-05-05T00:00:00Z

Document:
HARSCO CORPORATION, APPELLANT, v. TRACY, TAX COMMR., APPELLEE. 
[Cite as Harsco Corp. v. Tracy (1999), ___ Ohio St.3d ___.] 
Taxation — Franchise tax — Term “capital gain” as used in R.C. 5733.051(C) 
and (D) includes recaptured depreciation income attributable to the sale of 
Ohio assets. 
(No. 97-2006 — Submitted January 12, 1999 — Decided May 5, 1999.) 
APPEAL from the Board of Tax Appeals, No. 95-P-595. 
 
In 1989 Harsco Corporation sold substantially all the assets of its Astro 
Division based in Wooster, Ohio.  Approximately eighty-seven percent of Astro’s 
assets were located in Ohio; the others were located in two other states.  The sale 
price of $6.9 million assigned to the Astro Division’s fixed assets was less than 
the purchase price of $8.6 million.  Although there was a decrease in the value 
when considering the difference between the original purchase price and the sale 
price, there was income of approximately $4.4 million for federal tax purposes.  
The $4.4 million of income represented recapture of depreciation, i.e., the 
difference between the sale price of $6.9 million and the depreciated basis at the 
time of sale of $2.5 million. Depreciation recapture income is the portion of the 
gain on the sale of the property that results from the fact that in determining the 
gain, the basis of the property sold is adjusted by the amount of depreciation 
previously taken with respect to the property. 
 
When it filed its Ohio franchise tax return for tax year 1990, Harsco 
apportioned the $4.4 million in net income between Ohio and the other states 
where it filed tax returns based on net income. 
 
The Tax Commissioner audited Harsco’s return and imposed an additional 
assessment by allocating to Ohio eighty-seven percent of the $4.4 million.  
Allocation determines income based upon the situs of property that is the source 
of that income; here the situs of the property at the time of sale.  R.C. 
 
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5733.051(A)-(G).  Apportionment divides income from interstate business activity 
that is not allocated to a definite situs by using a formula based upon several 
factors.  R.C. 5733.051(H). 
 
Harsco filed an application for review, correction, and refund.  The 
commissioner affirmed his assessment and denied Harsco’s refund application.  
Harsco appealed to the Board of Tax Appeals (“BTA”). 
 
The BTA affirmed the commissioner’s assessment, thereby denying 
Harsco’s refund request. The BTA rejected Harsco’s contention that the gain 
should be allocated to Ohio in the same proportion as the depreciation deductions 
that had been apportioned to Ohio bore to the total depreciation deductions.  The 
BTA relied on Borden, Inc. v. Limbach (1990), 49 Ohio St.3d 240, 551 N.E.2d 
1268, which required that such gains be allocated based upon the situs of the 
property at the time of sale. The BTA also based its holding on the fact that the 
statutory provisions at issue, R.C. 5733.051(C) and (D), simply did not support 
the allocation method proposed by Harsco. 
 
This cause is now before the court upon an appeal as of right. 
__________________ 
 
Baker & Hostetler, L.L.P., Edward J. Bernert and George H. Boerger, for 
appellant. 
 
Betty D. Montgomery, Attorney General, and Richard C. Farrin, Assistant 
Attorney General, for appellee. 
__________________ 
 
COOK, J.  The question in this case is whether Borden controls Harsco’s tax 
situation, that is, whether the term “capital gain” as used in R.C. 5733.051(C) and 
(D) includes recaptured depreciation income attributable to the sale of Ohio assets. 
We find that Borden controls the outcome of this case, and we decline to 
reconsider the Borden analysis in light of years of taxpayers’ reliance on it. 
 
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I 
 
Harsco sets forth two contentions. First it argues that the $4.4 million in 
recaptured depreciation income should be allocated to Ohio based on the 
percentage of depreciation previously taken in Ohio, not the location of the assets 
when sold.  This procedure would result in a refund.  Harsco alternately contends 
that the term “capital gain” represents only the difference between the selling 
price and the original cost basis.  The result of either argument, in this case, is that 
there would be no allocation based on the percentage of assets with a situs in Ohio 
and the recaptured depreciation income would be apportioned under R.C. 
5733.051(H), applied year by year to the period of ownership.  Harsco has not 
pointed to, and we have not found, any statutory provisions that require or permit 
either of Harsco’s alternative propositions. 
 
According to Harsco, the three alternative methods to treat the gain on sale 
at issue are as follows: 
(1)  APPORTION ALL DEPRECIATION RECAPTURE 
 
Apportion the recaptured depreciation income among the states where 
Harsco does business by using the apportionment formula that is used for all 
income except that income which is specifically allocated under the Ohio statute.  
This method is (a) the method unsuccessfully proposed by the commissioner in 
Borden, and (b) the method that Harsco used to assign the recaptured depreciation 
income on its return. 
(2)  ALLOCATE ALL DEPRECIATION RECAPTURE 
 
Allocate the recaptured depreciation income based on the location at the 
time of sale of the physical assets upon which the cumulative depreciation had 
been calculated.  This is the method used by the commissioner to assess Harsco.  
It was approved by the BTA, although the BTA acknowledged that the application 
 
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to Harsco did result in a large disparity between recaptured depreciation income 
and the depreciation apportioned to Ohio over the years. 
(3)  ALLOCATE BASED ON APPORTIONMENT 
 
Allocate the recaptured depreciation income based on the amount of 
depreciation deductions that were taken against Ohio income using the 
apportionment factors during the period of ownership.  This method was asserted 
on Harsco’s application for refund, but was rejected by the commissioner and the 
BTA. This method best matches the income from the recaptured depreciation to 
the cumulative benefit of the Ohio depreciation deduction taken by Harsco during 
the ownership of the assets. 
 
Harsco asks that income from recaptured depreciation be allocated based on 
the depreciation deduction that had been assigned to Ohio during the period of 
ownership (method No. 3 above).  In the alternative, it asks that recaptured 
depreciation income be included with the apportioned income and assigned to 
Ohio by means of the apportionment formula (method No. 1 above). 
 
Harsco argues that method No. 2 above, the option implemented by the 
commissioner and approved by the BTA, is ill-conceived.  Harsco complains that 
application of Borden results in a large disparity between depreciation recaptured 
and depreciation apportioned to Ohio over the years. Harsco contends that the 
Borden holding fails to match the recaptured depreciation income with the benefit 
of the prior deductions. Harsco laments the unfairness of the result in this case.  It 
points to the fact that its cumulative depreciation deductions were not allocated 
based on the location of the property (only 8.1 percent had been attributable to 
Ohio), yet if Borden controls this situation, the income created solely because of 
the recapture of the prior depreciation deduction (eighty-seven percent allocated to 
Ohio) will be allocated rather than being correlated to the associated depreciation 
benefits. 
 
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On the other hand, the Tax Commissioner urges that this court’s 
interpretation in Borden controls.  He contends that the portion of the $4.4 million 
in recaptured depreciation attributable to Ohio represents capital gain as that term 
was interpreted in Borden and thus must be allocated to Ohio.  We agree. 
 
Harsco’s argument centers on the question: Is recaptured depreciation a 
“capital gain”?  Generally, this court would look to federal law for the definition 
of “capital gains.”  But a review of the federal tax law over the years shows that 
the federal treatment of capital gains has waxed and waned in response to political 
policies.  There is no consistent federal definition of the term upon which this 
court can rely.  Pursuant to Section 1001(a), Title 26, U.S.Code, gain is the excess 
of the amount realized over the adjusted basis of the property that is sold.  
Recaptured depreciation fits. 
 
Contrary to Harsco’s theory, recaptured depreciation income is not a 
separate item of income; it simply reflects the fact that depreciation previously 
taken on the property was considered in adjusting (reducing) the basis of the Astro 
property. Income resulting from the recapture of depreciation represents capital 
gain and is to be allocated for Ohio franchise tax purposes according to R.C. 
5733.051(C) and (D). 
 
The starting point for calculating the franchise tax on the net income basis 
is the taxpayer’s federal taxable income. R.C. 5733.04(I). After the appropriate 
adjustments to net income have been made, R.C. 5733.051(C) and (D) provide 
that certain income of the corporation is to be allocated as follows: 
 
“(C)  Capital gains and losses from the sale or other disposition of real 
property located in this state are allocable to this state; 
 
“(D)  Capital gains and losses from the sale or other disposition of tangible 
personal property are allocable to this state if the property had a situs in this state 
 
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at the time of sale and the taxpayer is otherwise subject to the tax imposed by this 
chapter.” 
 
The only method provided for allocating such gains pursuant to R.C. 
5733.051(C) and (D) is the location of the property sold.  There is nothing in 
either provision that allows an allocation of such gains based upon the 
apportionment of the depreciation deductions previously taken for the property. 
 
Borden dictates that we affirm the BTA’s decision. Harsco says that Borden 
does not ordain the result because of the real differences between income from 
capital gain and income from recaptured depreciation. That is, capital gain from 
the sale of property located in Ohio is obviously allocable to Ohio as opposed to 
other states, while the relation of recaptured depreciation income to Ohio is based 
on the amount of the deductions benefiting the taxpayer accumulated over the 
time of the ownership. But the only type of income involved in Borden was 
recaptured depreciation. 
 
In Borden the taxpayer sold real and personal property of one of its Florida 
divisions.  For federal income tax purposes, Borden recognized two types of 
income from the sale of the Florida property: (1) long-term capital gain from the 
sale of property used in trade or business and (2) ordinary income from 
disposition of depreciable personal and real property (recaptured depreciation) 
under Sections 1245 and 1250, Title 26, U.S.Code. 
 
When it filed its Ohio franchise tax, based on net income, Borden allocated 
to Florida both the long-term capital gain and the ordinary income representing 
the recaptured depreciation resulting from the sale.  Having allocated both types 
of income to Florida, Borden subtracted corresponding amounts of income from 
the net income to be apportioned.  The Tax Commissioner accepted Borden’s 
allocation of the long-term gain.  However, the commissioner contended that the 
portion of the income representing recaptured depreciation should not be allocated 
 
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to Florida, but instead it should be included in the income subject to 
apportionment.  This argument tracks with Harsco’s viewpoint. 
 
Writing for the majority in Borden, Justice Wright stated that no universal 
meaning for “capital gain” exists in the Internal Revenue Code and therefore the 
meaning of “capital gain” cannot be discerned from the Internal Revenue Code to 
be used to allocate income for Ohio’s franchise tax.  Borden, 49 Ohio St.3d at 
242-243, 551 N.E.2d at 1271.  The concept of “capital gain” is used in the federal 
tax system to categorize certain income for preferential tax rates.  However, as 
contrasted to the federal system, the concern of the Ohio franchise tax system with 
capital gain, as expressed in R.C. 5733.051(C) and (D), is to “direct where the 
gain is taxed, not how much of it is taxed.”  Id. at 241, 551 N.E.2d at 1270. 
 
This case represents the mirror image of Borden.  In Borden the situs of the 
property in question was outside Ohio; therefore, the recaptured depreciation was 
allocated outside Ohio, while here the situs of the  property sold is in Ohio. 
 
Appellant has set forth a compelling argument concerning the fairness of 
proportional allocation.  There is no statutory support, however, for its assertion 
that the recaptured depreciation income should be proportionally allocated based 
upon the past depreciation deductions taken in Ohio and other states.  And Borden 
holds differently. 
 
Harsco would have us ignore or overrule Borden, contending that no rule of 
law was announced, because it was an opinion by a justice without a syllabus. As 
announced, Borden is authoritative.  We decline to ignore or overrule Borden.  
This court ought to stay the course when it has only recently chosen one of two 
legitimate alternatives. Borden is nine years old, and during that time corporations 
and taxing authorities have acted in reliance upon it.  Certainty in the law is 
important to both businesses and taxing authorities.  If our decision in Borden was 
not what the General Assembly intended by R.C. 5733.051(C) and (D), it could 
 
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have enacted a definition for “capital gains” to change the outcome of future 
cases. Any correction coming from the General Assembly would be prospective 
and avoid the problems of retroactivity that would come with a reversal by this 
court of a legitimate position. 
II 
 
Harsco contends that the Commerce and Equal Protection Clauses of the 
United States Constitution prohibit the allocation of the recaptured  depreciation 
income to Ohio.  In support of its argument that allocation of the recaptured 
depreciation income violates the Commerce Clause, Harsco cites Complete Auto 
Transit, Inc. v. Brady (1977), 430 U.S. 274, 97 S.Ct. 1076, 51 L.Ed.2d 326.  
Harsco argues that allocation of the recaptured depreciation income violates the 
fair-apportionment and nondiscrimination prongs of the four-prong test for the 
taxation of interstate commerce set forth in Complete Auto.  But the question in 
Complete Auto was not whether certain income should be allocated or 
apportioned; the question in Complete Auto was whether Mississippi could impose 
its privilege tax upon interstate income.  In this case, the income sought to be 
allocated is not interstate income; it is income that can be identified as earned in 
Ohio. 
 
If all of Harsco’s income had been earned in Ohio, all of it would be 
allocated to Ohio and there would be no need to apportion any part of it to another 
state. In ASARCO, Inc. v. Idaho State Tax Comm. (1982), 458 U.S. 307, 315, 102 
S.Ct. 3103, 3108, 73 L.Ed.2d 787, 794, the court stated: “As a general principle, a 
State may not tax value earned outside its borders.”  The corollary to this is that a 
state may tax value earned within its borders.  If income is earned totally within a 
state and allocated to that state, then there can be no violation of Complete Auto, 
because (1) there is substantial nexus with the taxing state, (2) there is no 
discrimination against interstate commerce, (3) the tax is fairly related to services 
 
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provided by the state, and (4) the fourth prong requiring fair apportionment need 
not be considered because no other state would have a claim to the income. 
 
Ohio cannot control other states’ apportioning recaptured depreciation 
income that instead should be allocated solely to one state.  In Moorman Mfg. Co. 
v. Bair (1978), 437 U.S. 267, 279, 98 S.Ct. 2340, 2347, 57 L.Ed.2d 197, 208,  the 
court recognized that different states have different interpretations as to what is 
subject to taxation, stating, “[t]he potential for attribution of the same income to 
more than one State is plain.”  The court went on to state, however, that “[t]he 
prevention of duplicative taxation, therefore, would require national uniform rules 
for the division of income.”  Id. 
 
For the foregoing reasons, we find the decision of the Board of Tax Appeals 
to be reasonable and lawful; therefore, it is hereby affirmed. 
Decision affirmed. 
 
F.E. SWEENEY, PFEIFER and LUNDBERG STRATTON, JJ., concur. 
 
RESNICK, J., concurs in judgment. 
 
MOYER, C.J., and DOUGLAS, J., dissent. 
__________________ 
 
MOYER, C.J., dissenting.  I would overrule the holding of Borden, Inc. v. 
Limbach (1990), 49 Ohio St.3d 240, 551 N.E.2d 1268, and reverse the decision of 
the Board of Tax Appeals. 
 
DOUGLAS, J., concurs in the foregoing dissenting opinion.