Opinion ID: 1372015
Heading Depth: 1
Heading Rank: 1

Heading: Characterization of Capital Gains and Interest.

Text: The principal question presented is whether, under the Multistate Tax Compact, [1] the interest and capital gains from the sales of assets to British Petroleum and Pasco are business income, to be apportioned to and taxed by Colorado, or non-business income, allocable to and taxable by only states having the closest connection with the assets sold. Richfield contends that treating these items as business income, and apportioning them accordingly for tax purposes, would violate the commerce clause [2] and the Fourteenth Amendment of the United States Constitution. For the subject years, Richfield had elected to be taxed pursuant to the Multistate Tax Compact, Section 24-60-1301, C.R.S. 1973, which determines the Colorado taxable income of a corporation doing business both within and outside Colorado. The compact provides for taxation of a taxpayer's income by apportioning its business income and allocating its non-business income. Section 24-60-1301, Art. IV. Apportionment of business income is accomplished by aggregating all items of business income and apportioning that income among the compact taxing states according to a three-part formula based on property, payroll, and sales factors. Section 24-60-1301, Art. IV (9-17). The income thus apportioned to each state is subject to taxation by that state. In contrast, allocation of non-business income earmarks each item of such income to be attributed to and taxed only by the state with which the asset that generated that income is most closely associated, according to standards set out in Section 24-60-1301, Art. IV. The threshold step in this taxation process is to identify and segregate the taxpayer's business and non-business income. The compact defines business income as 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, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations. Section 24-60-1301, Art. IV(1)(a). Non-business income is defined as all income other than business income. Section 24-60-1301, Art. IV(1)(e). The parties disagree as to the proper construction of the statutory definition of business income and the appropriate application of the term to Richfield's income. Richfield maintains that the statute establishes a transactional test to determine whether certain income constitutes business income. That test turns on whether the income was derived from a transaction or activity in the regular course of trade or business. The crucial inquires are the frequency and regularity of the activity. See McVean & Barlow v. New Mexico Dept. of Rev., 88 N.M. 521, 543 P.2d 489 (1975); Western Natural Gas Co. v. McDonald, 202 Kan. 98, 446 P.2d 781 (1968). Richfield asserts that since it was not in the business of buying and selling large blocks of assets pursuant to court order, the capital gains and interest in issue must be classified as non-business income. The Director agrees that the first clause of the statutory definition establishes the transactional test described by Richfield. However, the Director contends that the second clause of the statutory definition sets out a functional test, under which all gain from the disposition of the property is considered business income if the property disposed of was used by the taxpayer in its regular trade or business operations. Under this test, the extraordinary nature or the infrequency of the transactions is irrelevant. See Sperry & Hutchinson Co. v. Dept. of Rev., 270 Or. 329, 527 P.2d 729 (1974); Appeal of Borden, Inc., Cal.S.Bd. of Equal. (Feb. 3, 1977). [3] In any event, the Director contends that application of either test mandates classification of Richfield's disputed capital gains and interest as business income. We affirm the district court's conclusion that holds that the income in issue is business income subject to apportionment and taxation in Colorado because it resulted from a transaction in the regular course of Richfield's business. In light of our action affirming this conclusion of the district court, we need not decide whether the second clause of the statute establishes a functional test to be applied to this income. Historically, Richfield, as part of its business operations, has regularly engaged in major acquisitions and dispositions of the same type involved here. From 1956 to 1977, it was involved in fifteen purchases or mergers and eleven sales of companies or blocks of assets aside from the sales at issue here. Such acquisitions and dispositions of assets constitute a systematic and recurrent business practice. Moreover, the sales of assets here at issue were anticipated results of the merger with Sinclair. Richfield's purpose was to acquire Sinclair's assets with the knowledge and understanding that some portion would have to be sold to avoid conflict with the antitrust laws. Regardless of court orders, consideration of the antitrust implications inherent in merging two oil companies of this magnitude is imperative. The disposition of assets to meet the requirements of the antitrust laws was neither unusual nor unforeseeable.