Title: Polaroid Corp. v. Offerman

State: north-carolina

Issuer: North Carolina Supreme Court

Document:

IN THE SUPREME COURT OF NORTH CAROLINA
No. 70PA98
POLAROID CORPORATION
v.
MURIEL K. OFFERMAN, Secretary of Revenue of the State of North
Carolina
On discretionary review pursuant to N.C.G.S. § 7A-31 of a
unanimous decision of the Court of Appeals, 128 N.C. App. 422,
496 S.E.2d 399 (1998), reversing an order entered by Cashwell,
J., on 28 February 1997 in Superior Court, Wake County, and
remanding for entry of summary judgment for plaintiff.  Heard in
the Supreme Court 12 October 1998.
Alston & Bird, P.L.L.C., by Jasper L. Cummings, Jr., for
plaintiff-appellee.
Michael F. Easley, Attorney General, by Andrew A. Vanore,
Jr., General Counsel; George W. Boylan, Special Deputy
Attorney General; and Kay Linn Miller Hobart, Assistant
Attorney General, for defendant-appellant.
Multistate Tax Commission, by Paull Mines, General Counsel,
amicus curiae.
WYNN, Justice.
Plaintiff Polaroid Corporation (“Polaroid”), a Massachusetts
corporation, develops, manufactures, and sells photographic
equipment.  As one of the world’s predominant manufacturers of
instant photographic equipment, Polaroid continually develops and
refines methods of designing and marketing those products.  Under
this market-leading approach, Polaroid has obtained an
extraordinary number of patents; however, it has never licensed
its core technology to an unrelated third party.
    Polaroid ultimately collected $924,526,554, the difference
1
constituting additional postjudgment interest.  
In 1976, Polaroid sued Eastman Kodak Company (“Kodak”) under
35 U.S.C. § 271(a) to enjoin Kodak’s alleged infringement of
Polaroid’s patents and to recover damages caused thereby. 
Approximately nine years thereafter, the United States District
Court for the District of Massachusetts ruled for Polaroid,
enjoined Kodak, and reserved the issue of damages for later
determination.  See Polaroid Corp. v. Eastman Kodak Co., 641 F.
Supp. 828 (D. Mass. 1985), aff’d, 789 F.2d 1556 (Fed. Cir.),
cert. denied, 479 U.S. 850, 93 L. Ed. 2d 114 (1986).
Following a hearing in 1990, that federal district court
resolved the damages issue by determining lost profits to be the
primary measure of damages and, as required under 35 U.S.C. §
284, by using the alternative “reasonable royalty” measure to set
a floor below which the damages could not fall.  See Polaroid
Corp. v. Eastman Kodak Co., 17 U.S.P.Q.2d 1711 (D. Mass. 1991). 
Accordingly, the final order awarded Polaroid damages of
$233,055,432 for “lost profits,” an additional $204,467,854 for
“lost profits” determined on the basis of a “reasonable royalty,”
and prejudgment interest in the amount of $435,635,685.1
As stated, the Kodak lawsuit did not occur in North
Carolina.  None of Polaroid’s property or personnel relating to
the Kodak lawsuit were located in this state, nor were any of the
infringed-upon patents utilized by Kodak.  Moreover, Polaroid did
not utilize the judgment proceeds in the regular course of its
business in North Carolina.  Indeed, the record indicates that
Polaroid used the proceeds to pay income taxes, repay debt,
redeem both preferred and common stock, and provide its employees
with a special bonus.
In 1991, Polaroid classified the Kodak judgment for North
Carolina corporate income-tax purposes as “nonbusiness income”
under N.C.G.S. § 105-130.4(a)(1).  Hence, Polaroid allocated the
entire judgment to Massachusetts, the state of its commercial
domicile.  The North Carolina Department of Revenue, however,
disagreed with Polaroid’s classification of the award as
nonbusiness income and therefore reclassified it as business
income.  This reclassification, in turn, increased Polaroid’s
North Carolina tax liability by $499,177.  After Polaroid
objected to the reclassification of the award as business income,
an administrative hearing was held before the Secretary of
Revenue, who upheld the Department of Revenue’s decision. 
Thereafter, Polaroid tendered the requisite amount and filed this
refund action under N.C.G.S. § 105-241.4.
The parties filed motions for summary judgment which were
heard at the 9 December 1996 Civil Session of the Superior Court,
Wake County, before the Honorable Narley L. Cashwell.  Judge
Cashwell, on 28 February 1997, granted the Secretary of Revenue’s
motion and denied Polaroid’s.  Thereafter, Polaroid appealed to
the Court of Appeals, which reversed the trial court’s decision
and remanded to the trial court for summary judgment for
Polaroid.  See Polaroid Corp. v. Offerman, 128 N.C. App. 422, 496
S.E.2d 399 (1998).
On 2 April 1998, this Court granted the Secretary of
    There are currently twenty-one full-member states of the
2
Multistate Tax Commission.  Member states differ from associate-
member states in that member states have enacted legislation
making the Compact a part of their statutory law.  Associate
states, on the other hand, though expressing a commitment to the
Commission’s goals, have not incorporated the Compact into their
statutory law.
Revenue’s petition for discretionary review to decide whether the
damages Polaroid received as a result of the Kodak lawsuit
constitute business income under N.C.G.S. § 105-130.4(a)(1).
I.  BACKGROUND
 North Carolina is one of seventeen states which comprise
the associate membership of the Multistate Tax Commission, an
administrative agency of the Multistate Tax Compact (“Compact”).  
2
The Compact was created to promote uniformity and compatibility
in significant components of state tax systems and to avoid
duplicative taxation.  In re Appeal of Chief Indus., 255 Kan.
640, 652, 875 P.2d 278, 286 (1994).  One of the Commission’s
central goals is to promote uniformity in the states’ taxation of
interstate and foreign commerce.  Additionally, uniformity among
the states with respect to taxation of interstate and foreign
commerce constitutes the basis behind the Compact’s almost word-
for-word incorporation of the Uniform Division of Income for Tax
Purposes Act, 7A U.L.A. 331 (1985) (“UDITPA”).  So, given North
Carolina’s commitment to the Compact and its goal of achieving
uniform taxation nationwide, it is not surprising that this
state’s Corporate Income Tax Act is modeled after UDITPA.  See
N.C.G.S. § 105-130.4 (1989); National Serv. Indus. v. Powers, 98
N.C. App. 504, 391 S.E.2d 509, appeal dismissed and disc. rev.
denied, 327 N.C. 431, 395 S.E.2d 685 (1990).
    North Carolina’s definition of business income is slightly
3
broader than the definition found under the Uniform Act. 
Specifically, North Carolina’s definition reads “acquisition,
management, and/or disposition of the property,” as opposed to
the definition in UDITPA, which uses the conjunction “and” rather
than “and/or.”  Moreover, North Carolina’s definition utilizes
the term “corporation” instead of “taxpayer.”  These distinctions
are irrelevant to the case sub judice.
Under both the North Carolina Corporate Income Tax Act and
UDITPA, a multistate or multinational corporation’s net taxable
income is divided into two classes:  (1) business income which is
apportioned among the Compact taxing states according to a three-
part formula based upon property, payroll, and sales factors,
N.C.G.S. § 105-130.4(i); and (2) nonbusiness income which is
allocated in a manner whereby it is taxed only by the state with
which the asset that generated the income is most closely
associated, N.C.G.S. § 105-130.4(h).  See National Serv. Indus.,
98 N.C. App. at 506-07, 391 S.E.2d at 511.
Thus, at the threshold, a taxpayer must identify and
segregate its “business” income from its “nonbusiness” income. 
Section 105-130.4(a)(1) of the North Carolina Corporate Income
Tax Act defines business income as
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.3
Nonbusiness income, on the other hand, is defined as “all income
other than business income.”  N.C.G.S. § 105-130.4(a)(5).
In the case sub judice, the parties disagree over the proper
construction of the statutory definition of business income. 
Unquestionably, the first clause of N.C.G.S. § 105-130.4(a)(1)
and UDITPA--which provides that business income is “income
arising from transactions and activity in the regular course of
the corporation’s trade or business”--sets forth the
“transactional test.”  Under the transactional test, to determine
whether business income is derived from a transaction or activity
in the regular course of the corporation’s trade or business, one
must consider the frequency and regularity of similar
transactions, the former practices of the business, and the
taxpayer’s subsequent use of the income.  See National Serv.
Indus., 98 N.C. App. at 508-09, 391 S.E.2d at 512; Ross-Araco
Corp. v. Commissioner of Bd. of Fin. & Revenue, 544 Pa. 74, 76,
674 A.2d 691, 693 (1996); Union Carbide Corp. v. Huddleston, 854
S.W.2d 87, 92 (Tenn. 1993).  Therefore, the central inquiry under
the transactional test revolves around the nature of the
particular transaction giving rise to the income.  See Union
Carbide Corp., 854 S.W.2d at 92.
With respect to the statutory definition’s second
clause--which provides that 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”--the
parties debate whether this clause simply modifies the first
clause or whether it sets forth a second, independent test for
business income.
Some state supreme courts read the second clause of UDITPA
as simply modifying the first clause and therefore hold that the
definition of business income under UDITPA contains only the
transactional test.  See, e.g., Phillips Petroleum Co. v. Iowa
Dep’t of Revenue & Fin., 511 N.W.2d 608 (Iowa 1993); In re Appeal
of Chief Indus., 255 Kan. 640, 875 P.2d 278; Federated Stores
Realty v. Huddleston, 852 S.W.2d 206 (Tenn. 1992).  However,
after these decisions, the legislatures of those states promptly
amended their respective tax statutes to explicitly include the
functional test within their definition of business income.  See
Act of May 1, 1995, ch. 141, sec. 1, 1995 Iowa Acts 256, 256
(effective retroactive to 1 January 1995); Act of May 17, 1996,
ch. 264, sec. 1, 1996 Kan. Sess. Laws 1868, 1868; Act of May 6,
1993, ch. 182, secs. 1, 2, 1993 Tenn. Pub. Acts 442, 442.
Other UDITPA states, however, recognized the second clause
as encompassing a second independent test known as the
“functional test.”  See, e.g., Pledger v. Getty Oil Exploration
Co., 309 Ark. 257, 831 S.W.2d 121 (1992); Texaco-Cities Serv.
Pipeline Co. v. McGaw, 182 Ill. 2d 262, 695 N.E.2d 481 (1998);
Simpson Timber Co. v. Department of Revenue, 326 Or. 370, 953
P.2d 366 (1998); Ross-Araco Corp. v. Commissioner of Bd. of Fin.
& Revenue, 544 Pa. 74, 674 A.2d 691.  These states concluded
either that the plain language of UDITPA includes the functional
test or that the definition of business income is ambiguous, and
therefore the respective state supreme courts had the right to
construe the statute to include the functional test.
Under the functional test, income is classified as business
income if it arises from the acquisition, management, and/or
disposition of an asset that was used by the taxpayer in the
regular course of business.  See Texaco-Cities, 182 Ill. 2d at
268, 695 N.E.2d at 484.  When determining whether a source of
income constitutes business income under the functional test, the
extraordinary nature or infrequency of the event is irrelevant. 
Id.
In the instant case, we are called upon to determine whether
the second clause of N.C.G.S. § 105-130.4(a)(1) should be
construed as modifying the first clause, thereby mandating that
business income include only those transactions that occur in the
regular course of the corporation’s business, or whether the
second clause encompasses the independent functional test,
thereby allowing extraordinary transactions to constitute
business income so long as the relevant asset was used by the
corporation in the regular course of business.  This
determination is of particular import in this case because
Polaroid’s recovery from the Kodak lawsuit constitutes an
extraordinary or unusual transaction which provided Polaroid with
income from assets--the patents--which are integral parts of its
regular trade or business operations.
We note that National Serv. Indus., 98 N.C. App. 504, 391
S.E.2d 509, is the only North Carolina case addressing the
“business income” issue.  In that case, our Court of Appeals was
asked to decide whether income obtained from “safe-harbor leases”
of electric-generating equipment constituted business income when
the taxpayer was not in the business of generating, leasing, or
selling electricity or electrical equipment.  Id. at 508, 391
S.E.2d at 512.  In finding that the income constituted business
income under North Carolina’s statutory definition, the Court of
Appeals stated that the determinative question was “whether the
return on [the taxpayer’s] investment is an integral part of the
[taxpayer’s] trade or business.”  Id.  The Court then concluded
that since the lease arrangement was a means of gaining working
capital and increasing cash flow for all of the taxpayer’s
business operations, it accordingly was an “integral part” of the
taxpayer’s business.  Id.  The Court, however, failed to
determine the threshold issue of whether this state’s statutory
definition of business income includes the functional test.  We
now address this issue of first impression--whether North
Carolina’s statutory definition of “business income” contains the
functional test--by using the canons of statutory construction,
pertinent administrative rules, and the legislative history
surrounding both the Act itself and UDITPA.
A.  STATUTORY CONSTRUCTION
Under the canons of statutory construction, the cardinal
principle is to ensure accomplishment of the legislative intent. 
See L.C. Williams Oil Co. v. NAFCO Capital Corp., ___ N.C. App.
___, ___, 502 S.E.2d 415, 417 (1998).  To that end, we must
consider “the language of the statute . . . , the spirit of the
act and what the act seeks to accomplish.”  Coastal Ready-Mix
Concrete Co. v. Board of Comm’rs, 299 N.C. 620, 629, 265 S.E.2d
379, 385 (1980).  Moreover, undefined words are accorded their
plain meaning so long as it is reasonable to do so.  See Woodson
v. Rowland, 329 N.C. 330, 338, 407 S.E.2d 222, 227 (1991). 
Further, the Court will evaluate the statute as a whole and will
not construe an individual section in a manner that renders
another provision of the same statute meaningless.  See Williams
v. Holsclaw, 128 N.C. App. 205, 212, 495 S.E.2d 166, 170, aff’d,
___ N.C. ___, 504 S.E.2d 784 (1998).  Significantly, in matters
of statutory construction, an ambiguous tax statute shall be
strictly construed against the state and in favor of the
taxpayer.  See In re Appeal of Clayton-Marcus Co., 286 N.C. 215,
219, 210 S.E.2d 199, 202 (1974).
In this case, Polaroid contends, inter alia, that under
N.C.G.S. § 105-130.4(a)(1), business income “arise[s] from
transactions or activit[ies] in the regular course of the
corporation’s trade or business” and that the phrase “and
includes” merely modifies this first clause by providing examples
of what fits within the definition.  The Secretary of Revenue, on
the other hand, argues that the statutory definition of business
income contains a compound predicate and thus encompasses both
the transactional test and the functional test.
Under the preceding rules of statutory construction, we
cannot agree with Polaroid’s contention that the second clause of
N.C.G.S. § 105-130.4(a)(1) simply modifies that section’s first
clause by providing examples of business income.  First,
grammatically speaking, business income constitutes the subject
of the sentence, which is thereafter defined by two independent
clauses, each with its own verb and subsequent definitional
language.  In fact, the statute could grammatically be read as
stating:  “Business income means income arising from transactions
and activity in the regular course of the corporation’s trade or
business, and [business income] includes income from tangible and
intangible property . . . .”  That is, N.C.G.S. § 105-130.4(a)(1)
does not contain a misplaced modifier, but rather utilizes a
compound predicate to illustrate that “business income” includes
the definitions set forth in both the first and second clauses. 
See Kroger Co. v. Department of Revenue, 284 Ill. App. 3d 473,
479, 673 N.E.2d 710, 713 (1996), appeal denied, 171 Ill. 2d 567,
677 N.E.2d 966 (1997).
Moreover, the General Assembly’s decision to employ
different language between the two clauses further demonstrates
its intention of defining business income in a manner
encompassing both the transactional test and the functional test. 
Indeed, the first clause states that business income can arise
from “transactions or activity” in the “regular course” of the
corporation’s “trade or business.”  N.C.G.S. § 105-130.4(a)(1). 
The second clause, on the other hand, states that business income
can arise from “property” which constitutes “integral parts” of
the corporation’s “trade or business operations.”  Id. 
Therefore, the triggering events in the first clause--
“transactions or activities”--are replaced in the second phrase
by the triggering events of “acquir[ing], manag[ing], and/or
dispos[ing] of . . . property.”  Moreover, the predicate phrase
found in the first clause--“in the regular course of the
corporation’s trade or business”--is replaced in the second
clause with “integral parts of the corporation’s regular trade or
business operations.”  Accordingly, the second clause contains a
    Oregon’s definition of business income differs slightly from
4
North Carolina’s definition in that Oregon’s definition refers to
the “acquisition, the management, use or rental, and the
disposition of property constitut[ing] integral parts of the
taxpayer’s regular trade or business operations.”  Or. Rev. Stat.
§ 314.610(1) (1987) (emphasis added).  The addition of “use or
rental” to the definition does not change the analysis with
respect to whether the second clause of the definition
constitutes an independent test for business income. 
definition distinct from that set forth in the first.
Our reading of N.C.G.S. § 105-130.4(a)(1) comports with that
of other state supreme courts which have confronted this exact
argument with respect to similarly worded statutes.  For example,
in Texaco-Cities Serv. Pipeline Co. v. McGaw, 182 Ill. 2d 262,
695 N.E.2d 481, Texaco-Cities argued that income is business
income only if it arises from transactions and activities
occurring in the regular course of the taxpayer’s business.  The
Supreme Court of Illinois, in rejecting this argument, stated:
The first clause consists of general language
encompassing all activity in the “regular course of the
taxpayer’s trade or business.”  The second clause
enlarges this definition to include income from
property, as long as its “acquisition, management, and
disposition” constitute “integral parts of the
taxpayer’s regular trade or business operations.”
Id. at 270, 695 N.E.2d at 485 (quoting 35 Ill. Comp. Stat.
5/1501(a)(1) (West 1994)).  The court then concluded that the
functional test was consistent with the plain language of the
statute.  Id.
Similarly, in Simpson Timber Co. v. Department of Revenue,
326 Or. 370, 953 P.2d 366, the Supreme Court of Oregon held that
its definition of business income--also modeled after
UDITPA--encompassed the functional test.   In Simpson, the Oregon
4
court was asked to determine whether monies received by Simpson
    A dragline is a large piece of equipment used in the surface
5
mining of hard minerals.
Timber as compensation for the federal government’s condemnation
of its timberland and timber constituted business income.  Id. at
374, 953 P.2d at 368.  Simpson Timber argued that because it did
not voluntarily dispose of the property, the disposition could
not constitute an integral part of its regular business
operations.  Id. at 375, 953 P.2d at 369.  The Supreme Court of
Oregon, in rejecting this argument, construed Oregon’s definition
of business income as including “[i]ncome from tangible and
intangible property . . . ‘if’ the ‘acquisition,’ ‘management,’
‘use,’ and ‘disposition’ of [it] are integral parts of taxpayer’s
regular business operations.”  Id. at 374, 953 P.2d at 369
(quoting Or. Rev. Stat. § 314.610(1) (1987)).  The Oregon court
concluded that since the timber and the land on which it was
growing were assets admittedly acquired and used as integral
parts of Simpson Timber’s business, the income received from
those assets, no matter how acquired, constituted business
income.  Id. at 376, 953 P.2d at 370.
New Mexico also applies an approach which, though utilizing
the phrase “use test” instead of “functional test,” appears to be
consistent with our holding.  See Kewanee Indus. v. Reese, 114
N.M. 784, 845 P.2d 1238 (1993).  In Kewanee, the Supreme Court of
New Mexico was asked to determine whether rental income received
from dragline  leases constituted business income when the lessor
5
was an oil and gas company which had no history of leasing or
financing assets of any kind.  Id. at 786, 845 P.2d at 1240.  The
New Mexico court, in classifying the income as business income,
defined the use test as an inquiry into whether the income
received constituted a gain beyond mere appreciation from a
passive investment.  Id. at 789, 845 P.2d at 1243. 
Significantly, the New Mexico court cited a lower court’s
construction of section 72-15A-17(A) (now codified as N.M. Stat.
Ann. § 7-4-2), defining business income as including income
arising from “‘situations in which “. . . the acquisition,
management, and disposition of the property constitute integral
parts of the taxpayer’s regular trade or business operations.”’” 
Id. at 788, 845 P.2d at 1242 (quoting McVean & Barlow, Inc. v.
New Mexico Bureau of Revenue, 88 N.M. 521, 522-23, 543 P.2d 489,
490-91 (Ct. App.), cert. denied, 89 N.M. 6, 546 P.2d 71 (1975)).
Lastly, we note that our holding is consistent with that of
the Supreme Court of Pennsylvania, which found its definition of
business income to encompass both the transactional and
functional tests.  See Laurel Pipe Line Co. v. Commissioner of
Bd. of Fin. & Revenue, 537 Pa. 205, 642 A.2d 472 (1994).  In
Laurel, the Pennsylvania court partly analyzed the issue of
whether its UDITPA-based definition of business income included
the functional test by referring to other states’ discussion on
the issue.  Id. at 208, 642 A.2d at 475.  The Pennsylvania court 
concluded that the second clause of the definition sets forth an
alternative and independent “functional” test by which earnings
may be characterized as business income if the earnings arise
from the acquisition, management, and disposition of property
which constitutes integral parts of the taxpayer’s regular trade
or business.  Id.  Specifically, the court stated that under the
functional test, the gain arising from the sale of an asset will
be classified as business income if the asset produced business
income while it was owned by the taxpayer.  Id. at 210, 642 A.2d
at 475.
In reaching a conclusion contrary to both this Court’s and
other state supreme courts’ rulings, our Court of Appeals relied
upon a 1917 probate case, Miller v. Johnston, 173 N.C. 62, 69, 91
S.E. 593, 597 (1917), wherein this Court interpreted the phrase
“including the five front half-acre lots” in a manner such that
the term “including” could not be construed as “in addition to.” 
The Court of Appeals improperly relied upon this holding.
First, Miller involved discerning the intent of a devisee,
not statutory construction.  Moreover, this Court construed the
modifying term “including,” not the conjunctive phrase “and
includes” at issue here.  Notably, subsequent to Miller, this
Court stated that the word “includes,” as set forth in this
state’s Turnpike Authority Act, indicates the General Assembly’s
intention to enlarge, not limit, the statutory definition.  See
N.C. Turnpike Auth. v. Pine Island, Inc., 265 N.C. 109, 143
S.E.2d 319 (1965); see also Baker v. Chavis, 306 S.C. 203,
208-09, 410 S.E.2d 600, 603 (1991) (concluding that the phrase
“shall include” indicates an intent to enlarge the statutory
definition, not limit it).  Therefore, we conclude that  the
Court of Appeals erroneously relied on our prior ruling in Miller
when it determined that the phrase “and includes” cannot be read
as meaning “in addition to.”
Given our determination that the plain language of N.C.G.S.
§ 105-130.4(a)(1) encompasses both the transactional test and the
functional test, we now focus upon the second clause’s plain
language to define the functional test.  First, we note that the
phrase “acquisition, management, and/or disposition” contemplates
the indicia of owning corporate property.  See Texaco-Cities, 182
Ill. 2d at 270, 695 N.E.2d at 485.  Moreover, Webster’s
Dictionary defines “integral” as meaning “essential to
completeness.”  Merriam-Webster’s Collegiate Dictionary 607 (10th
ed. 1993).  Therefore, reading the second clause as a whole,
business income includes income obtained from acquiring,
managing, and/or disposing of property which is essential to the
corporation’s business operations.
In sum, both the general rules of statutory construction and
the plain language of N.C.G.S. § 105-130.4(a)(1) lend support to
the conclusion that this state’s definition of business income
for corporate income-tax purposes includes both the transactional
test and the functional test.  To hold otherwise would be to
improperly read the conjunctive phrase “and includes” as the
modifying term “including.”  Moreover, it would ignore general
rules of grammar and syntax by displacing business income as the
overriding subject for that section.  See Valentine v. Gill, 223
N.C. 396, 398, 27 S.E.2d 2, 5 (1943) (“we need hardly go much
further than the grammatical construction and syntax of the law
to find its meaning”).
B.  ADMINISTRATIVE RULE 17 NCAC 5C .0703
We find further support for our ruling in North Carolina
Administrative Rule 17 NCAC 5C .0703.  “The construction adopted
by the administrators who execute and administer a law in
question is one consideration where an issue of statutory
construction arises.”  John R. Sexton & Co. v. Justus, 342 N.C.
374, 380, 464 S.E.2d 268, 271 (1995).  This Court has said that
such construction is “strongly persuasive” and therefore is
entitled to “due consideration.”  See Shealy v. Associated
Transp., Inc., 252 N.C. 738, 742, 114 S.E.2d 702, 705 (1960). 
Indeed, “an interpretation by the Secretary of Revenue is prima
facie correct.  When the Secretary of Revenue interprets a law by
adopting a rule or publishing a bulletin on the law, the
interpretation is a protection to the officers and taxpayers
affected by the interpretation.”  In re Petition of Vanderbilt
Univ., 252 N.C. 743, 747, 114 S.E.2d 655, 658 (1960); see
N.C.G.S. § 105-264 (Supp. 1994).
Since the inception of the North Carolina Corporate Income
Tax Act, the Secretary of Revenue has adopted the UDITPA approach
of defining business income to include both the transactional
test and the functional test.  The UDITPA approach has been
reflected in the Secretary of Revenue’s administrative rules
since 1976 and is currently set forth in North Carolina
Administrative Rule 17 NCAC 5C .0703--labeled “Business and
Nonbusiness Income”--which provides in pertinent part:
The classification of income by the labels
customarily given them, such as interest, rents,
royalties, capital gains, is of no aid in determining
whether that income is business or nonbusiness income. 
The gain or loss recognized on the sale of property,
for example, may be business income or nonbusiness
income depending upon the relation to the taxpayer’s
trade or business: 
. . . .
(2)
A gain or loss from the sale, exchange or
other disposition of real or personal
property constitutes business income if the
property while owned by the taxpayer was used
to produce business income. . . . 
. . . .
(5)
Patent and copyright royalties are business
income if the patent or copyright was created
or used as an integral part of a principal
business activity of the taxpayer.
17 NCAC 5C .0703(2), (5) (June 1998) (emphasis added).  The plain
language of this rule clearly demonstrates the Secretary of
Revenue’s interpretation of business income as encompassing the
functional test.  Moreover, Polaroid has failed to produce
sufficient evidence to rebut the presumption that the Secretary
of Revenue’s interpretation is prima facie correct.  Therefore,
we conclude that rule 17 NCAC 5C .0703 further supports our
holding that business income, as defined under the North Carolina
Corporate Income Tax Act, includes the functional test.
Further, it is significant that the Secretary of Revenue’s
interpretation, as codified in rule 17 NCAC 5C .0703, has
remained virtually unchanged for over twenty years.  On the other
hand, the General Assembly has revised the North Carolina
Corporate Income Tax Act numerous times, and the specific statute
at issue in the case sub judice has been amended six times.  See
Act of June 18, 1982, ch. 1212, 1981 N.C. Sess. Laws (Reg. Sess.
1982) 108, 108 (clarifying when a corporation may apportion part
of its net income or net loss to another state); Act of Aug. 13,
1987, ch. 804, sec. 2, 1987 N.C. Sess. Laws 1695, 1695 (providing
for apportionment of business income of an air or water
transportation corporation); Act of June 27, 1988, ch. 994, sec.
1, 1987 N.C. Sess. Laws (Reg. Sess. 1988) 176, 176 (amending the
formula used to apportion the income of multistate corporations
to this state for income taxation and to conform the formula for
payment of estimated taxes to the federal formula); Act of
July 24, 1993, ch. 532, sec. 12, 1993 N.C. Sess. Laws 2239, 2264
(changing mandatory language to permissive); Act of June 29,
1995, ch. 350, sec. 3, 1995 N.C. Sess. Laws 828, 829 (making
conforming changes to tax law in light of federal law preempting
state regulation of most motor freight carriers); Act of Aug. 2,
1996, ch. 14, sec. 5, 1995 N.C. Sess. Laws (2d Extra Sess. 1996)
589, 592 (reforming unconstitutional tax provisions).  We
reiterate that the legislature is always presumed to act with
full knowledge of prior and existing law and that where it
chooses not to amend a statutory provision that has been
interpreted in a specific way, we may assume that it is satisfied
with that interpretation.  See State v. Benton, 276 N.C. 641,
658-59, 174 S.E.2d 793, 804-05 (1970).  We further reiterate that
“long acquiescence in the practical interpretation of a statute
is entitled to great weight in arriving at its meaning.”  State
v. Emery, 224 N.C. 581, 587, 31 S.E.2d 858, 862 (1944).  Thus,
the absence of any pertinent amendment for so long a period,
especially given the General Assembly’s willingness to amend
other provisions of the Corporate Income Tax Act, indicates
legislative approval of the Secretary of Revenue’s construction
of the statute.
In summation, we conclude that the Secretary of Revenue’s
interpretation of business income as defined under N.C.G.S. §
105-130.4(a)(1) is entitled to due consideration and considered
prima facie correct.  This prima facie presumption is significant
given Polaroid’s failure to adequately rebut the Secretary of
Revenue’s interpretation.  Moreover, the General Assembly’s
failure to amend N.C.G.S. § 105-130.4(a)(1) demonstrates its
implied acquiescence in the Secretary of Revenue’s
interpretation, thereby providing further support for our
conclusion that the North Carolina Corporate Income Tax Act
defines business income in a manner encompassing both the
transactional and functional tests.
C. LEGISLATIVE HISTORY
Additional support for our determination that North
Carolina’s definition of business income includes the functional
test can be found in the legislative history surrounding both the
North Carolina Corporate Income Tax Act and UDITPA.  In
determining the legislative intent behind North Carolina’s
Corporate Income Tax Act, this Court should consider not only the
language utilized by the General Assembly, but also the history,
spirit, and goals of the Act.  See Mark IV Beverage, Inc. v.
Molson Breweries USA, Inc., ___ N.C. App. __, ___, 500 S.E.2d
439, 442 (1998).  Also, because it is well established that the
North Carolina Corporate Income Tax Act was based upon UDITPA and
prefaced upon meeting the goals of the Multistate Tax Compact,
the policies underlying both UDITPA and the Compact lend a better
understanding of the meaning behind North Carolina’s Act.
UDITPA was designed to apportion among the states in which a
multistate or multinational corporation does business the fair
amount of net taxable business income earned by the corporation’s
activities in each state.  See Pledger, 309 Ark. at 262, 831
S.W.2d at 124.  UDITPA was needed because the divergence in state
tax laws unfairly subjected multistate corporations to tax
liability on greater than 100% of their income and debilitated
their profit margins by increasing their compliance costs.  Id. 
UDITPA was drafted to reduce this diversity and to therefore
eliminate the accompanying overtaxation and high compliance costs
associated with it.
We note that the uniform definition of business income, as
set forth in UDITPA, finds its origins in early California
jurisprudence.  James H. Peters, The Distinction Between Business
Income and Nonbusiness Income, 25 S. Cal. Tax Inst. 251, 272
(1973).  Interestingly, the original draft of UDITPA failed to
distinguish between business and nonbusiness income and was
amended to reflect such a distinction only after the State of
California suggested the value of such a distinction.  Id. at
275.  Ultimately, the uniform definition of business income was
modeled after a proposed definition submitted by John Warren of
California to the California State Tax Board in February 1965. 
Id.  In that letter, Mr. Warren discussed the allocation of
royalty income and stated:
[W]e felt the treatment of royalties was in conflict
with the decisions of the State Board of Equalization
. . . which had upheld formula apportionment of such
income where the acquisition, management and
disposition of the patents or copyrights constituted
integral parts of the taxpayer’s regular trade or
business.
Id.  The final draft of UDITPA encompasses this formula
apportionment approach and thereby provides for the direct
allocation of income only to the extent that such income is
classified as nonbusiness income.  Id.; see also Texaco-Cities,
182 Ill. 2d at 272, 695 N.E.2d at 486 (stating that the
functional test was “adopted directly from the comment underlying
the UDITPA”).
Further, in In re Appeal of Borden, Inc., Cal. St. Bd. of
Equal., Cal. Tax Rep. (CCH) ¶ 205-616 (Feb. 3, 1997), the
California Board of Equalization was faced with the question of
whether the second prong of UDITPA contained the functional test. 
The Board determined that the uniform definition of business
income encompassed the functional test and therefore held that
“income from assets which are an integral part of the taxpayer’s
business is subject to apportionment by formula, regardless of
whether the income may arise from an occasional or extraordinary
transaction.”  Id. at 24, Cal. Tax Rep. (CCH) ¶ 205-616, at
14,897-59.  In so ruling, the Board noted the recent rejections
of the functional test by two other states but dismissed them as
improper because those courts did not consider the fact that the
uniform definition was derived from California jurisprudence and
did not examine the uniform regulations interpreting the
definition.  Id. at 26, Cal. Tax Rep. (CCH) ¶ 205-616, at
14,897-59.  Moreover, the Board noted that these decisions were
in direct conflict with the Multistate Tax Commission’s
regulations.  Id.
The preceding probe into the policies underlying the
drafting of UDITPA convincingly shows that the UDITPA definition
of business income encompasses the functional test.  As stated,
the North Carolina Corporate Income Tax Act was patterned after
UDITPA.  See National Serv. Indus., 98 N.C. App. at 506, 391
S.E.2d at 511.  Moreover, the timing of the adoption of the North
Carolina Corporate Income Tax Act--effective 1 July 1967--
illustrates that North Carolina was reacting to the nationwide
trend of adopting legislation which increased the uniformity and
compatibility of state income-tax laws with respect to interstate
commerce.  Therefore, we conclude that North Carolina embraced
both the uniform definition and the national trend and
accordingly adopted the functional test as part of its definition
of business income.
II.  APPLICATION
Given our determination that the North Carolina Corporate
Income Tax Act defines business income to include the functional
test, we must now consider the question of whether Polaroid’s
award in the Kodak lawsuit constitutes business income under that
test.  As stated, Polaroid’s damage award comprised three
separate categories of relief:  (1) $233,055,432 for “lost
profits,” (2) $204,467,854 for “lost profits” determined on the
basis of a “reasonable royalty” as required under 35 U.S.C. §
284, and (3) $487,003,268 constituting prejudgment and
postjudgment interest.  We will address the classification of
each category respectively.
A.  LOST PROFITS
It is undisputed that Polaroid’s patents are an “integral
    We do note, however, that cases involving liquidation are in
6
a category by themselves.  Indeed, true liquidation cases are
inapplicable to these situations because the asset and
transaction at issue are not in furtherance of the unitary
business, but rather a means of cessation. 
part of its regular trade or business operations.”  Indeed, in
its brief, Polaroid notes that Kodak’s infringement constituted a
“potentially devastating threat to the business of Polaroid” and
that protection of Polaroid’s patents was crucial to its ability
to carry on its regular trade or business operations.  Therefore,
the patents can be characterized only as integral income-
producing assets.
In the case sub judice, the question becomes whether income
from these integral assets should be classified as nonbusiness
income when that income is obtained as a result of court
proceedings, rather than from marketplace sales.  We hold that
once a corporation’s assets are found to constitute integral
parts of the corporation’s regular trade or business, income
resulting from the acquisition, management, and/or disposition of
those assets constitutes business income regardless of how that
income is received.6
First, we note United States Supreme Court jurisprudence
indicating that damages recovered by a patentee under 35 U.S.C. §
284 constitute compensation for any pecuniary loss suffered and
are intended to return the patentee to the same condition in
which it would have been had the infringement not occurred.  See
Aro Mfg. Co. v. Convertible Top Replacement Co., 377 U.S. 476,
507, 12 L. Ed. 2d 457, 480 (1964).  Indeed, the Supreme Court has
explicitly stated that under the current statutory framework, an
infringed-upon patentee can recover only its damages, as opposed
to recovering profits obtained by the infringer or other monies
punitive in nature.  Id. at 506, 12 L. Ed. 2d at 480.
Using the aforementioned cases for general guidance, we now
turn more specifically to two state supreme court cases outside
of this jurisdiction which more directly guide us to our result. 
First, in Simpson Timber, the Supreme Court of Oregon was asked
to determine whether condemnation proceeds resulting from a
government taking of timberland and timber constituted business
income.  Simpson Timber, 326 Or. 370, 953 P.2d 366.  The Oregon
court, in classifying the proceeds as business income, first
noted that the ultimate sources of the income were the standing
timber and the land upon which it was growing--assets admittedly
acquired and used as integral parts of the taxpayer’s business. 
Id. at 376, 953 P.2d at 370.  The court continued: “[W]hen 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.”  Id.  Thus, the court held that “[w]hether
the conditions and terms of that sale were set by law, including
constitutional law, does not alter that concept.  Nor does it
alter the additional fact that the compensation paid by the
government for the timberland was compensation paid for property
that the taxpayer intended to use to produce ‘business income.’” 
Id. at 375, 953 P.2d at 369.  Therefore, the court implicitly
held that income received “in lieu of” prospective profits--
income that would normally be characterized as business income--
is considered business income for corporate income-tax purposes.
Similarly, in Dover Corp. v. Department of Revenue, 271 Ill.
App. 3d 700, 648 N.E.2d 1089, appeal denied, 163 Ill. 2d 552, 657
N.E.2d 618 (1995), an Illinois appellate court held that a
patent-infringement judgment representing reasonable royalties
constituted business income under UDITPA.  In so ruling, that
court stated that “royalty income does not become nonbusiness
income merely because Dover enforced its right to receive such
income through litigation.”  Id. at 712, 648 N.E.2d at 1097. 
That is, the court determined that the patents themselves were
integral assets used in Dover’s regular trade or business
operations, and therefore any income obtained from the assets via
the judgment constituted income “in lieu of” profits it would
normally have received absent the infringement.  Accordingly,
since those profits would have been taxed as business income, any
monies received “in lieu of” those profits should be taxed
similarly.
We find the holdings in Simpson Timber and Dover persuasive. 
It is undisputed that the Kodak judgment was designed to
compensate Polaroid for Kodak’s infringement of its patents. 
Moreover, it is undisputed that Polaroid’s patents were an
integral part of its regular trade or business operations.  In
fact, Polaroid’s primary source of income results from the sale
of products based upon its patents.  Therefore, given that the
Kodak judgment constituted “income” stemming from the
“acquisition, management, and/or disposition” of Polaroid’s
integral assets and in lieu of normal marketplace sales, we hold
that it should be classified as business income for North
Carolina corporate income-tax purposes.
Further, this Court is guided by United States Supreme Court
precedent with respect to taxing litigation awards.  In United
States v. Safety Car Heating & Lighting Co., 297 U.S. 88, 80 L.
Ed. 500 (1936), the United States Supreme Court held that in
patent-infringement cases, compensatory damages representing lost
profits should be taxed in the same manner as if the profits were
earned in the normal manner.  Significantly, both statutory law
and United States Supreme Court jurisprudence provide that
patent-infringement damage awards are intended to put the
infringed-upon party in the same pecuniary position as if the
infringement had never occurred.  See 35 U.S.C. § 284 (1981); Aro
Mfg. Co., 377 U.S. at 507, 12 L. Ed. 2d at 480.  These damage
awards implicitly provide infringed-upon parties with the profits
they would have received from sales absent the infringement--
profits which undeniably would have been taxable as business
income.  Since the Kodak judgment constitutes income “in lieu of”
profits Polaroid ordinarily would have obtained in the
marketplace, we hold that the “lost profits” award fits squarely
within the functional test and this state’s definition of
business income.
B.  “REASONABLE ROYALTY”
We now consider whether the portion of Polaroid’s judgment
which represents “reasonable royalties” constitutes business
income under the functional test.  As stated, Polaroid has never
licensed out its patents to an unrelated third party, and
accordingly, Polaroid has never received royalties as a
percentage of its business income.  Therefore, Polaroid argues
that under the “in lieu of” approach set forth in the preceding
section of this opinion, this Court cannot find that the
“reasonable royalties” it recovered under the Kodak judgment
constituted income “in lieu of” that which it would have received
absent Kodak’s infringement.
The Secretary of Revenue, on the other hand, argues that
North Carolina Administrative Rule 17 NCAC 5C .0703(5) is
directly on point.  Under rule 17 NCAC 5C .0703(5), “[p]atent and
copyright royalties are business income if the patent or
copyright was created or used as an integral part of a principal
business activity of the taxpayer.”  Therefore, the Secretary of
Revenue argues that since there is no dispute that the patents at
issue were created and used as integral parts of Polaroid’s
business, the amount Polaroid received as a reasonable royalty is
properly classified as business income.  Neither of these
arguments guides our determination of this issue.
Instead, we consider the pertinent patent-law statute, 35
U.S.C. § 284.  Under that statute, a party whose patent is found
to be infringed upon is entitled to recover “damages adequate to
compensate for the infringement, but in no event less than a
reasonable royalty for the use made of the invention by the
infringer, together with interest and costs as fixed by the
court.”  (Emphasis added.)  Significantly, section 284 
contemplates a distinction between “damages” and “profits”
recoverable in a patent-infringement suit:  “In patent
nomenclature, what the infringer makes is ‘profits,’ what the
owner of the patent loses by such infringement is ‘damages.’” 
Duplate Corp. v. Triplex Safety Glass Co., 298 U.S. 448, 451, 80
L. Ed. 1274, 1278 (1936).
Prior to 1946, the statutory precursor to section 284, Rev.
Stat. § 4921, allowed both damages and profits to be recovered. 
See Aro Mfg. Co., 377 U.S. at 505, 12 L. Ed. 2d at 479.  In 1946,
however, Congress amended the statute to allow an infringed-upon
patentee to recover only “damages.”  See 35 U.S.C. § 284; Aro
Mfg. Co., 377 U.S. at 505, 12 L. Ed. 2d at 479.  The purpose of
this change was to ensure that a patentee’s recovery was limited
only to those “damages” it suffered as a result of the
infringement.  Aro Mfg. Co., 377 U.S. at 505, 12 L. Ed. 2d at
479.  Indeed, prior to this amendment, a patentee could recover
not only the damages it suffered as a result of the infringement,
but also any profits made by the infringer so as to force the
infringer to disgorge the fruits of the infringement.  See
General Motors Corp. v. Devex Corp., 461 U.S. 648, 654, 76 L. Ed.
2d 211, 217 (1983).  The patentee could recover those profits
even if the infringement itself caused the patentee no harm.  Id.
As stated, 35 U.S.C. § 284 allows the award of a reasonable
royalty so long as the amount constitutes “damages” resulting
from the infringement.  See Aro Mfg. Co., 377 U.S. at 505, 12 L.
Ed. 2d at 479.  These damages, in turn, are defined as
constituting “‘compensation for the pecuniary loss [the patentee]
has suffered from the infringement, without regard to the
question whether the defendant has gained or lost by his unlawful
acts.’”  Id. at 507, 12 L. Ed. 2d at 480 (quoting Coupe v. Royer,
155 U.S. 565, 582, 39 L. Ed. 263, 269 (1895)).  Moreover, these
damages “constitute ‘the difference between [the patentee’s]
pecuniary condition after the infringement and what [its]
condition would have been if the infringement had not occurred.’” 
Id. (quoting Yale Lock Mfg. Co. v. Sargent, 117 U.S. 536, 552, 29
L. Ed. 954, 960 (1886)).  Thus, the pertinent question to be
answered when determining damages is “how much had the Patent
Holder . . . suffered by the infringement.  And that question
[is] primarily:  had the Infringer not infringed, what would
Patent Holder-Licensee have made?”  Livesay Window Co. v. Livesay
Indus., 251 F.2d 469, 471 (5th Cir. 1958).
The preceding rules used to determine damages in patent-
infringement suits apply in two situations.  In the first
situation, the patentee exercises its patent rights by granting
licenses to others, and the infringer is liable for damages
because it acted without a license.  See Marvel Specialty Co. v.
Bell Hosiery Mills, Inc., 386 F.2d 287, 290 (4th Cir. 1967), 
cert. denied, 390 U.S. 1030, 20 L. Ed. 2d 286 (1968).  In this
situation, the court will determine a reasonable royalty by
inquiring into whether the patentee has established a fixed
royalty.  Id.  If no fixed royalty has been established, the
court will thereafter inquire into what constitutes a reasonable
royalty given the facts presented.  Id.  The second situation
involves those times when the patentee exercises its patent
rights through a policy of not licensing out its patents and
thereby maintains the patent and any accompanying invention as a
close monopoly.  Id.  In this situation, there is no established
royalty, and therefore the patentee’s damages consist of “the
money [the patentee] would have realized from a monopoly if there
had been no infringement as, for example, the sales [the
patentee] would have made and the profits [the patentee] would
have realized, or what would have been a reasonable royalty had
the patentee undertaken to grant licenses.”  Id.  In either case,
if the patentee cannot prove its damages by a sufficient showing
of lost profits or the establishment of a fixed royalty, the
court must establish a reasonable royalty to provide the patentee
with adequate compensation for the infringement.  See Panduit
Corp. v. Stahlin Bros. Fibre Works, Inc., 575 F.2d 1152 (6th Cir.
1978).
There are two established means of determining a reasonable
royalty.  The first requires an analysis into the infringer’s own
internal profit projections and motives.  See TWM Mfg. Co. v.
Dura Corp., 789 F.2d 895, 898 (Fed. Cir.), cert. denied, 479 U.S.
852, 93 L. Ed. 2d 117 (1986).  The second, more common, approach
involves the construction of a hypothetical negotiation between a
willing licensor and a willing licensee.  See Trilogy
Communications, Inc. v. Comm Scope Co., 754 F. Supp. 468, 512
(W.D.N.C. 1990); Georgia-Pacific Corp. v. U.S. Plywood Corp., 318
F. Supp. 1116 (S.D.N.Y. 1970), modified and aff’d, 446 F.2d 295
(2d Cir.), cert. denied, 404 U.S. 870, 30 L. Ed. 2d 114 (1971). 
In either case, “the calculation is not a mere academic exercise
in setting some percentage figure as a ‘royalty.’  The
determination remains one of damages to the injured party.” 
Fromson v. Western Litho Plate & Supply Co., 853 F.2d 1568, 1574
(Fed. Cir. 1988).  In reality, this device is a legal fiction
designed to compensate when profits are not provable, partly
because the patentee decided not to license its patents.  Id. 
Moreover, it comports with the overarching goal of patent-
infringement damage law to place the patent holder in as good a
position as that in which it would have been absent the
infringement.  See General Motors Corp., 461 U.S. at 655, 76 L.
Ed. 2d at 217.
The preceding consideration of the pertinent patent-law
statute and relevant case law convincingly demonstrates that the
term “reasonable royalty,” as set forth in 35 U.S.C. § 284, is a
legal fiction used to help measure the damages an infringed-upon
party is entitled to recover when that party is unable to produce
satisfactory evidence of lost profits.  Significantly, case law
illustrates that “reasonable royalties” are used to return the
patentee to the same pecuniary position it would have been in
absent the infringement.  Indeed, even a cursory reading of the
trial court’s damages opinion reveals that the trial judge based
his “reasonable royalty” decision upon what he believed Polaroid
would have earned absent Kodak’s infringement.  It follows that
in those situations where the patentee decides to keep a close
monopoly and not grant licenses, the “reasonable royalty”
measure, in reality, represents lost profits.  See Marvel
Specialty Co., 386 F.2d at 290.  Therefore, in those situations
where the patentee decides not to license out its patents, we
equate damages recovered under the label “reasonable royalties”
with lost profits.
Given our determination that the reasonable royalties equate
to lost profits, we accordingly reject Polaroid’s argument that
this aspect of its recovery cannot be assessed as income “in lieu
of” lost profits.  Moreover, because this part of the award does
not, in reality, represent royalties, we reject the Secretary of
Revenue’s application of rule 17 NCAC 5C .0703(5).  Rather, we
hold that Polaroid’s “reasonable royalty” recovery constitutes
business income because it is income received “in lieu of”
profits that, absent the infringement, would constitute business
income and be taxable as such.
C.  PREJUDGMENT AND POSTJUDGMENT INTEREST
Lastly, Polaroid contends that any interest it received as a
result of the Kodak judgment does not constitute business income
because it “would not have allowed its normal business accounts
to be overdue long enough to produce over $450 million in
interest.”  That is, the interest could not consist of income “in
lieu of” that which would have been earned absent the
infringement.  Again, we find Polaroid’s argument without merit.
According to the United States Supreme Court, a court
determining damages in a patent-infringement lawsuit should
ordinarily consider interest “to ensure that the patent holder is
placed in as good a position as that in which he would have been
had the infringer entered into a reasonable royalty agreement.” 
General Motors Corp., 461 U.S. at 655, 76 L. Ed. 2d at 217. 
Indeed, the United States Supreme Court has held that an award of
prejudgment interest to a patentee was necessary to ensure full,
complete, and adequate compensation since the patentee’s damages
consisted not only of the value of the lost royalty payments, but
also of the foregone use of the money between the time of the
infringement and the date of the judgment.  Id.; see also Waite
v. United States, 282 U.S. 508, 509, 75 L. Ed. 494, 495 (1931). 
Thus, United States Supreme Court jurisprudence demonstrates that
an infringed-upon patentee’s recovery of interest constitutes
compensation for income it would have earned absent the
infringement--income that would have been taxable as business
income had it been obtained in the marketplace as opposed to the
courtroom.  Because the interest portion of the Kodak judgment
constituted interest Polaroid received “in lieu of” that which it
otherwise would have received from its own investments,
classifying the interest portion of the judgment as business
income fits squarely within our “in lieu of” formula of
apportioning damages.
We find further support for our conclusion in North Carolina
Administrative Rule 17 NCAC 5C .0703(3).  Under rule 17 NCAC 5C
.0703(3):
Interest income is business income if the intangible
with respect to which the interest is received arises
out of or was created by a business activity of the
taxpayer and in those situations where the purpose for
acquiring the intangible is directly related to the
business activity of the taxpayer.
In this case, Polaroid’s patents arose out of and were created by
Polaroid’s business activities.  Further, Polaroid’s purpose for
acquiring the patents is undoubtedly related to its primary
business activity of selling instant photographic equipment. 
Additionally, the interest income at issue arose out of the Kodak
lawsuit and accompanying judgment.  The interest represented
income lost as a result of Polaroid’s being unable to earn
interest on the monies it should have received from sales absent
the infringement.  Thus, to the extent that the damage award
constitutes prejudgment and postjudgment interest, it is properly
characterized as business income.
With respect to Polaroid’s argument that it would not have
allowed that much interest to accrue in overdue accounts, we note
that a decision to award interest in a patent-infringement
lawsuit is in the trial court’s discretion and will be set aside
only if it constitutes an abuse of discretion.  See General
Motors Corp., 461 U.S. at 657, 76 L. Ed. 2d at 219.  Because
Polaroid has failed to produce adequate evidence demonstrating
that the trial court abused its discretion, we affirm the amount
of the interest awarded.
III.  CONSTITUTIONALITY
Finally, Polaroid argues that should we construe N.C.G.S. §
105-130.4(a) as including the functional test, then we must
conclude that it violates the Due Process Clause of the United
States Constitution by taxing income it has no power to tax and
that it violates the Commerce Clause by overtaxing corporations
doing business in interstate commerce.  See Allied-Signal, Inc.
v. Director of Div. of Taxation, 504 U.S. 768, 119 L. Ed. 2d 533
(1992) (holding a state may not constitutionally tax income
unless it is attributable to “business activities” within the
state).  We find Polaroid’s argument without merit.
Under the United States Constitution, a corporation’s
“entire net income . . . generated by interstate as well as
intrastate activities [can] be fairly apportioned among the
States for tax purposes by formulas utilizing in-state aspects of
interstate affairs.”  Northwestern States Portland Cement Co. v.
Minnesota, 358 U.S. 450, 460, 3 L. Ed. 2d 421, 428 (1959).  North
Carolina has determined its fair taxable share utilizing a
formula which examines the in-state aspects of a corporation’s
property, payroll, and sales.  See N.C.G.S. § 105-130.4(i). 
Moreover, the apportionment formula utilized by North Carolina is
the same one the Supreme Court found constitutional in Butler
Bros. v. McColgan, 315 U.S. 501, 86 L. Ed. 991 (1942), and more
recently cited with approval in Container Corp. of America v.
Franchise Tax Bd., 463 U.S. 159, 77 L. Ed. 2d 545 (1983).
Furthermore, to successfully challenge the constitutionality
of a state’s apportionment scheme, a taxpayer must demonstrate by
“clear and cogent evidence” that the scheme results in
extraterritorial values being taxed.  See Butler Bros., 315 U.S.
at 507, 86 L. Ed. at 996.  Polaroid has failed to provide such
evidence.
Finally, North Carolina can constitutionally tax Polaroid’s
recovery from the Kodak lawsuit under the unitary business
principle.  According to the unitary business principle, a state
may tax a corporation on an apportionable share of the multistate
business carried on in part in the taxing state.  See Allied-
Signal, Inc., 504 U.S. at 778, 119 L. Ed. 2d at 546.  “In order
to exclude certain income from the apportionment formula, the
corporation must prove that the income was earned in the course
of activities unrelated to those carried out in the taxing
State.”  Exxon Corp. v. Wisconsin Dep’t of Revenue, 447 U.S. 207,
223, 65 L. Ed. 2d 66, 81 (1980).  For example, a state may
include within a nondomiciliary corporation’s apportionable
income interest earned on deposits in a bank located outside of
the state, if that income forms part of the corporation’s working
capital.  See Allied-Signal, Inc., 504 U.S. at 777-78, 119 L. Ed.
2d at 546-47.
In this case, Polaroid’s judgment from the Kodak lawsuit
constitutes income earned from activities related to North
Carolina.  The judgment partly represents profits which Polaroid
would have earned absent Kodak’s infringement.  Those profits
would have properly been considered apportionable income had they
been earned in the normal manner.  The fact that they were
received in the courtroom instead of the marketplace is
irrelevant.  Moreover, the monies received from the Kodak lawsuit
were used as part of Polaroid’s working capital and therefore
constitute part of Polaroid’s unitary business.  Therefore, North
Carolina acted within its constitutional rights by classifying
the Kodak judgment as business income and taxing it accordingly.
IV.  CONCLUSION
We conclude that the definition of business income under the
North Carolina Corporate Income Tax Act includes the functional
test.  This ruling is based upon canons of statutory
construction, pertinent administrative rules, and the legislative
history surrounding both the Act itself and UDITPA.  Moreover,
given that Polaroid’s recovery constituted income in lieu of
profits, that income should be classified as business income
because it represents the disposition of assets integral to
Polaroid’s regular trade or business operations.  Lastly, under
United States Supreme Court jurisprudence, we conclude that
subjecting Polaroid’s recovery from the Kodak lawsuit to North
Carolina income tax is constitutional under the unitary business
principle.
REVERSED.