Opinion ID: 1677983
Heading Depth: 1
Heading Rank: 1

Heading: The parties present the dispute as one of pure statutory construction. It involves Iowa Code section 422.32(2) (1993), which provides:

Text: 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, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations. The statute must be understood in the light of its purpose. The commerce clause of the federal Constitution allows states to tax income of foreign corporations doing business within its borders. Cases interpreting the commerce clause allow taxation of income derived from the corporation's activities beyond the state's borders only in accordance with the unitary-business principle. Under that principle the state may tax a portion of income derived elsewhere only if the activities were related to the corporate business activities within the state. Allied-Signal, Inc. v. Director, Div. of Taxation, 504 U.S. ___, ___, 112 S.Ct. 2251, ___, 119 L.Ed.2d 533, 547 (1992); Mobil Oil Corp. v. Commissioner of Taxes, 445 U.S. 425, 439-40, 100 S.Ct. 1223, 1232-33, 63 L.Ed.2d 510, 522 (1980). So long as states comply with these metes and bounds they are free to adopt their own scheme for taxing income of foreign corporations doing business locally. Because of the problems inherent in accommodating various schemes, a number of states have adopted the uniform division of income for tax purposes act (UDITPA). See Asarco, Inc. v. Idaho State Tax Comm'n, 458 U.S. 307, 310, 102 S.Ct. 3103, 3105, 73 L.Ed.2d 787, 791 (1982). Iowa adopted it verbatim in 1979 as present Iowa Code section 422.32(2). See 1978 Iowa Acts ch. 1141, § 1. The present dispute comes down to whether, as the department contends, the statute provides for two tests, one transactional and one functional. Phillips contends the statute provides but one (transactional) test. According to the department, the statute focuses separately on a first test described in the first sixteen quoted words (transactional test) and those described in the last twenty-five quoted words (functional test). The two are separated by the words and includes. Accordingly the department reads the statute to set up the following two tests, either of which would satisfy the definition of business income: 1. Transactional test: Income is classified as business income if it arises from the transactions and activities in the regular course of the taxpayer's trade or business. 2. Functional test: Income is classified as business income if it arises 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. Phillips on the other hand argues that the functional test merely acts to limit the scope of the transactional test. Under Phillips' interpretation income must satisfy both tests before it can be called business income. Not surprisingly the department argues in the alternative that the income at issue here satisfies both tests, and Phillips asserts that it satisfies neither. Cases from other jurisdictions, while occasionally according lip service to a second (functional) test, quite uniformly reject it as a vehicle for allowing taxation under circumstances similar to those here. Pledger v. Getty Oil Exploration Co., 831 S.W.2d 121, 125 (Ark.1992) (recognizing functional test but disallowing tax); Western Nat'l Gas Co. v. McDonald, 202 Kan. 98, 100-01, 446 P.2d 781, 783 (1968) (applying transactional test only in rejecting tax upon complete liquidation); Union Carbide v. Huddleston, 854 S.W.2d 87, 94 (Tenn.1993) (rejects existence of alternative functional test in disallowing tax). Contra Atlantic Richfield Co. v. State, 198 Colo. 413, 601 P.2d 628, 632 (1979) (allowing tax on transactional test theory); Tipperary Corp. v. New Mexico Bureau of Revenue, 93 N.M. 22, 29, 595 P.2d 1212, 1219 (1979) (same). We think the test for identifying business income under Iowa Code section 422.32(2) is basically transactional, existing largely though not exclusively in those situations described by the first sixteen words quoted earlier. The concluding twenty-six words, source of the so-called functional test, are added to include transactions involving disposal of fixed assets by taxpayers who emphasize the trading of assets as an integral part of regular business. See General Care Corp. v. Commissioner of Revenue, 705 S.W.2d 642, 645 (Tenn.1986) (in looking to the function of an asset, the acquisition, management and disposition must be considered in making the determination, all must be integral parts of the taxpayer's regular trade or business operations). We take from the stipulation that Phillips' ownership of the disposed assets was for purposes of petroleum production, not for trading purposes. We conclude that the sale of Phillips' assets did not constitute business income under the functional test theory. II. The trial court did not reach the functional test; rather it rested its decision allowing the tax on the basis of the transactional test. We cannot agree that the transactional test was met because we think the sale did not occur in the regular course of Phillips' business. To be sure a complete liquidation did not occur, a point the trial court considered significant. The enormity of the disposition was nevertheless unprecedented, clearly a once-in-a-corporate-lifetime occurrence. Atlantic Richfield, 198 Colo. at 417, 601 P.2d at 631 (stating that the crucial inquiry under the transactional test is the frequency and regularity of the activity). The disposition of assets here was irregular, not only in its scope, but also in its nature. It did not occur as an accommodation of Phillips' petroleum production. Rather the transaction was aimed at a wholesale restructuring of the corporation's capital structure. It was error to disallow the income tax refund on the ground that the sale of assets was business income under Iowa Code section 422.32(2). REVERSED.