Title: Willamette Industries, Inc. v. Dept. of Rev.

State: oregon

Issuer: Oregon Supreme Court

Document:

FILED:  NOVEMBER 17, 2000
IN THE SUPREME COURT OF THE STATE OF OREGON
WILLAMETTE INDUSTRIES, INC., &
SUBSIDIARIES; and WILLAMETTE
INDUSTRIES, INC., transferee of 
BEND WILLAMETTE CORPORATION,

Appellants,
	v.
DEPARTMENT OF REVENUE,
State of Oregon,
Respondent.
(OTC 3050; SC S46137)
	On appeal from the Oregon Tax Court.*
	Carl N. Byers, Judge.
	Argued and submitted November 10, 1999.
	Philip N. Jones, Duffy, Kekel, Jones & Bernard, LLP,
Portland, argued the cause for appellant.  With him on the briefs
was Peter J. Duffy, Portland.
	Marilyn J. Harbur, Assistant Attorney General, Salem, argued
the cause for respondent.  With her on the briefs was Hardy
Myers, Attorney General.
	Before Carson, Chief Justice, and Gillette, Van Hoomissen,
Durham, Leeson, and Riggs, Justices.**
	DURHAM, J.
	The judgment of the Tax Court is reversed, and the case is
remanded to that court for further proceedings.
	*12 OTR 291 (1992).
	**Kulongoski, J., did not participate in the consideration
or decision of this case. 
	DURHAM, J.
	Taxpayers appeal a judgment entered by the Oregon Tax
Court after it concluded that taxpayers' royalty income
attributable to out-of-state mineral rights was "business
income."  We have jurisdiction under ORS 305.445.  Because
taxpayers' complaint was filed in 1990, we review de novo, ORS
305.445 (1989), and taxpayers must prove their claims by a
preponderance of the evidence.  ORS 305.427; Delta Air Lines,
Inc. v. Dept. of Rev., 328 Or 596, 603, 984 P2d 836 (1999).  For
the following reasons, we reverse the decision of the Tax Court.
	Taxpayers constitute a forest products business that
grows timber and uses that timber to make lumber, plywood,
particle board, fiberboard, cardboard, and paper.  As the Tax
Court summarized:
		"The parties stipulate that during 1971 through
1983, Willamette, and two of its subsidiaries, received
net oil and gas royalty income from unrelated companies
drilling on portions of their timberlands in Louisiana,
Arkansas and Oregon.  The stipulation specifies the
amount of income received by each company during each
year in each state.  Willamette allocated the oil and
gas royalties from the timberland to the states where
the timberland was located.  Most of the oil and gas
royalty income was allocated to either Louisiana or
Arkansas."
Willamette Industries, Inc. v. Dept. of Rev., 12 OTR 291, 292
(1992).
	The Department of Revenue (department) determined that
taxpayers' receipt of royalty income from the unrelated companies 
was part of their regular course of business activities and,
therefore, was taxable as business income in Oregon.  Relying
principally on the department's rules, the Tax Court agreed that
the out-of-state royalty income was business income and entered a
judgment in favor of the department.  Id. at 292-95.  Taxpayers
appealed.
	Taxpayers assert that the Tax Court's ruling is
erroneous for two reasons.  First, taxpayers argue that the
administrative rule that the Tax Court used in its analysis
expands the meaning of business income beyond the scope of the
statutory definition.  Second, taxpayers argue that their out-of-state mineral rights royalties fall outside Oregon's statutory
definition of business income.	ORS 314.815 provides that the department may make such
rules and regulations, not inconsistent with legislative
enactments, as it considers "necessary to enforce income tax
laws."  In this instance, the pertinent legislative enactment,
ORS 314.610(1), defines "business income" as follows:
		"'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,
the management, use or rental, and the disposition of
the property constitute integral parts of the
taxpayer's regular trade or business operations."
(Emphasis added.)  That statute is part of the Uniform Division
of Income for Tax Purposes Act (UDITPA), ORS 314.605 to 314.675,
which is a uniform statute that several states, including Oregon,
have adopted.  The department promulgated OAR 150-314.610(1)(B)
to explain its interpretation of ORS 314.610(1).  OAR 150-314.610(1)(B) provides in part:
		"Income of any type or class and from any source
is business income if it arises from transactions and
activity occurring in the regular course of a trade or
business.  Accordingly, the critical element in
determining whether income is 'business income' or
'nonbusiness income' is the identification of the
transactions and activity which are the elements of a
particular trade or business.  In general, all
transactions and activities of the taxpayer which are
dependent upon or contribute to the operations of the
taxpayer's economic enterprise as a whole constitute
the taxpayer's trade or business and will be
transactions and activity arising in the regular course
of, and will constitute integral parts of, a trade or
business.  The following are rules and examples for
determining whether particular income is businesses or
nonbusiness income. * * *
		 "(1) Rents and royalties from real and tangible
property.  Rental income from real and tangible
property is business income if the property with
respect to which the rental income was received is used
in the taxpayer's trade or business or is incidental
thereto and therefore is includable in the property
factor under OAR 150-314.655(1)-(A)." 
(Emphasis added.)  Taxpayers contend that that rule is overly
broad.
	ORS 314.610(1) provides that income from property is
taxable if the acquisition, management, use or rental, and
disposition of the property constitute integral parts of the
taxpayer's regular trade or business operations.  The statute
does not define the term "integral."  The dictionary definition
of "integral" is as follows: 
	"* * * 1a: of, relating to, or serving to form a whole:
essential to completeness: * * * c: formed as a unit
with another part (as the main part): -- often used
with; * * * 2: composed of constituent parts making a
whole * * *." 
Webster's Third New Int'l Dictionary, 1173 (unabridged ed 1993)
(emphasis in original).	OAR 150-314.610(1)(B)(1), by contrast,
provides that royalties are business income if the property, with
respect to which the income is received, is used in the
taxpayer's trade or business or if it is incidental thereto.  The
definition of "incidental" is: 
	"* * * 1: subordinate, nonessential, or attendant in
position or significance: as a: occurring merely by
chance or without intention or calculation: occurring
as a minor concomitant * * * b: being likely to ensue
as a chance or minor consequence * * * c: lacking
effect, force, or consequence: not receiving much
consideration or calculation: * * * d: presented
purposefully but as though without consideration or
intention * * * 2: met or encountered casually or by a
accident: CHANCE[.]"  
Webster's Third New Int'l Dictionary at 1142 (emphasis in
original).
	We cannot reconcile the statutory standard, "integral,"
with the disparate standard in the rule, "incidental."  Under the
rule, practically all the property of a taxpayer might qualify as
a source of business income, because all the property of a
business helps produce income for the business at least to an
incidental degree.  However, the statute requires the property
from which the taxpayer derives income to constitute an integral
part of the taxpayer's business.  The department's rule exceeds
the scope of the statutory definition of "business income."  
	The rule is an improper exercise of agency rulemaking
authority.  We therefore conclude that OAR 150-314.610(1)(B)(1)
is invalid to the extent that it treats as "business income" the
income from property that merely is incidental to a taxpayer's
trade or business.  We next examine ORS 314.610(1) to determine
whether taxpayers' royalty income is business income under that
statute.
	In Simpson Timber Company v. Dept. of Rev., 326 Or 370,
374, 953 P2d 366 (1998), the court recognized that ORS 314.610(1)
defines business income as income derived from two sources.  The
first source is "income arising from transactions and activity in
the regular course of the taxpayer's trade or business."  We will
refer to that portion of the definition as a "transactional"
test.
	The second source is "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." 
We will refer to that portion of the definition as a "functional"
test.
	The transactional test posits that business income
arises from transactions in the regular course of the taxpayer's
business.  By contrast, the functional test dictates that
acquisition, management, use or rental, and disposition of
property must constitute integral parts of regular business
operations.  Under the functional test, income includes, for
example, royalty income if the acquisition, management, use or
rental, and disposition of the property that produces the royalty
is also an integral part of the taxpayer's regular business
operations.
	Taxpayers may prevail only if we conclude that the
royalty income in question satisfies neither the transactional
test nor the functional test.  See Simpson Timber, 326 Or at 374-77 (applying solely the functional test in affirming Tax Court's
determination that "delay compensation" was business income);
Sperry & Hutchinson v. Dept. of Rev., 270 Or 329, 331-33, 527 P2d
729 (1974) (applying solely the transactional test). (1)
	In Sperry & Hutchinson, the taxpayer (S&H) was in the
trading stamp business (i.e., "green stamps").  "S & H's primary
business and the only business conducted in Oregon [was] the sale
of a trading stamp promotional service to retailers."  270 Or at
331.  This court applied only the transactional test and
determined that the issue was whether S&H's investment income was
"income arising from transactions * * * in the regular course of
the taxpayer's trade or business" under ORS 314.610(1).  S&H
invested in three categories of securities:  (1) short-term
securities held pending use of the funds in the green stamp
business; (2) short-term securities held pending acquisition of
other companies or favorable developments in the long-term money
market; and (3) long-term securities held as an investment.  Id.
at 331.  This court ruled that only the first category, the
short-term securities that S&H held pending use of those funds in
the green stamp business, constituted income arising in the
regular course of business.  Id. at 331-33.  That was so because
S&H held those short-term securities to satisfy its needs for
liquid capital in the green stamp business.  As a result, that
income was apportionable as business income.  Id. at 332-33.  The
other funds that S&H held for investment purposes were not linked
directly to the green stamp business and, consequently, were not
transactions in the regular course of business operations.  Id.
at 331-32.
	In Simpson Timber, a timber products company (similar
to taxpayers in this case) owned timber land that the government
had condemned and taken for public use.  The government had paid
the owner-taxpayer compensation for the land, together with
interest for its delay in paying that compensation ("delay
compensation").  326 Or at 372.  The issue presented was whether
the interest payments constituted "business income."  Applying
only the functional test, this court held:
		"The ultimate source of the income here was the
standing timber and the land on which it was growing,
assets admittedly acquired and used in taxpayer's
business as integral parts of it.  The disposition was
of those business assets.
		"We conclude that, when the timber and land on
which it was growing were disposed of by an involuntary
sale to the government through condemnation, that
disposition was as much an integral part of the
taxpayer's regular business operations for purposes of
the statutory definition as were the initial
acquisition, management, and use of the timberland. 
The additional amount paid because of delay in paying
the fair market price is but added income from that
regular business disposition.  ORS 314.610(1) defines
that income as unitary 'business income.'"
Id. at 376-77 (emphasis added). 
	Applying the transactional test here, as discussed in
Sperry & Hutchison, it does not appear that the royalty that
taxpayers received constituted income arising from transactions
and activity in the regular course of taxpayers' business. 
Taxpayers' business is growing timber and making wood products,
not producing oil and gas.  Receiving royalties on mineral rights
was not in the regular course of taxpayers' business as a forest
products company.
	Applying the functional test, as discussed in Simpson
Timber, we again conclude that taxpayers' royalty income is not
business income under the statute.  The functional test addresses
transactions involving property, more specifically, the property
of businesses that sell or otherwise dispose of property.  In
Simpson Timber, an actual disposition of the land and timber
occurred, even though it was a forced disposition through a 
government taking.  Here, by contrast, there was no disposition
of the land that contained the minerals.  Because there was no
actual disposition of the land, taxpayers cannot fulfill the
statutory element of a disposition as required under the
functional test.
	Even if we view the minerals alone as the property, we
reach the same result.  In Simpson Timber, the government taking
was a compelled disposition of the land and, especially, the
timber.  The department levied a tax on the interest income
associated with the forced disposition.  Here, taxpayers disposed
of minerals, and the department seeks to tax the royalty income
associated with the minerals.  The acquisition, management, use
or rental, and disposition of the minerals were not an integral
part of taxpayers' regular business operations.  Trading in
minerals was not an integral part of the business of
manufacturing forest products.  The evidence shows that it is not
essential to taxpayers' business that taxpayers own the
underlying mineral rights to their timber lands.  Thus, the
acquisition, management, use or rental, and disposition of the
minerals were not integral to taxpayers' regular business
operations of harvesting timber and making forest products. 
Taxpayers' royalty income, therefore, is not taxable as business
income in Oregon.
	In sum, we conclude that adoption of OAR 150-314.610(1)(B)(1) was an improper exercise of agency rulemaking
authority for the reasons stated above.  Further, under the
definition of "business income" set out in ORS 314.610(1),
taxpayer's out-of-state royalty income from its mineral rights
was not taxable business income in Oregon.
	The judgment of the Tax Court is reversed, and the case
is remanded to that court for further proceedings.

1. 	Courts of the states that have adopted statutes similar
to ORS 314.610(1) have split as to whether the functional test is
a subset of the transactional test or whether it is a separate
and independent basis for determining business income.  Some
courts have held that the second part merely modifies or
qualifies the first, and does not constitute a separate test. 
See, e.g., Ex Parte Uniroyal Tire Co., ___ Ala ___, __ So2d __
(2000) (available at 2000WL 1074041 (August 4, 2000)).  Others
have held that the second part is an independent basis for
determining business income.  See, e.g., Pledger v. Getty Oil
Exploration Co., 309 Ark 257, 831 SW2d 121 (1992).  This court's
holdings in Simpson Timber and Sperry & Hutchinson are consistent
with the latter view.