Opinion ID: 1410890
Heading Depth: 1
Heading Rank: 2

Heading: classification of income

Text: ASARCO challenged the commission's apportionment of its income from dividends, interest, rentals, capital gains and royalties as being inconsistent with a proper interpretation of the definition of business income found in I.C. § 63-3027(a)(1) and as being in violation of the due process and commerce clauses of the United States Constitution. We consider first the issue of statutory construction and second the constitutional issues.
Business income is defined as: 63-3027. COMPUTING TAXABLE INCOME OF NONRESIDENT PERSONS AND ANY CORPORATIONS.  ... (a) As used in this section, unless the context otherwise requires: (1) `Business income' means income arising from transactions and activity in the regular course of the taxpayers' trade or business and includes income from the acquisition, management, or disposition of tangible and intangible property when such acquisition, management, or disposition constitute integral or necessary parts of the taxpayers' trade or business operations. Gains or losses and dividend and interest income from stock and securities of any foreign or domestic corporation shall be presumed to be income from intangible property, the acquisition, management, or disposition of which constitute an integral part of the taxpayers' trade or business; such presumption may only be overcome by clear and convincing evidence to the contrary. ... (Emphasis indicates provisions not part of the uniform act but added by the Idaho legislature.) [2] A few general comments concerning this definition of business income are necessary in order to put the issues raised in this appeal in the proper perspective. First, the income referred to in subsection (a)(1) is income arising from the taxpayer's trade or business which is conducted, in part at least, in this state. Some corporations, particularly large conglomerates, may be engaged in several separate and distinct trades or businesses. The state may include as business income only the taxpayer's income arising from a trade or business conducted in this state and is not entitled to apportion income arising from a trade or business having no connection with this state. However, whether a number of business operations having common ownership constitute a single or unitary business or several separate businesses for tax purposes depends upon whether they are of mutual benefit to one another and on whether each operation is dependent on or contributory to others. Great Lakes Pipe Line Co. v. Commissioner of Taxation, 272 Minn. 403, 408, 138 N.W.2d 612, 616 (1965), appeal dismissed 384 U.S. 718, 86 S.Ct. 1886, 16 L.Ed.2d 881 (1966). See Sperry & Hutchinson Co. v. Department of Revenue, 270 Or. 329, 527 P.2d 729 (1974); Idaho State Tax Comm. Reg. 27.IV.1.(b). [3] This qualification, though not directly stated by the statute's literal language, is required by the theory underlying apportionment statutes, i.e., that the business income of a unitary business operating in several states cannot be precisely identified with particular states, see generally, Butler Bros. v. McColgan, 315 U.S. 501, 62 S.Ct. 701, 86 L.Ed. 991 (1942); Keesling & Warren, The Unitary Concept in the Allocation of Income, 12 Hastings L.J. 42 (1960), and by the constitutional requirement that there must be some minimal connection between the interstate business activities generating the income and the state seeking to tax that income. See Moorman Mfg. Co. v. Bair, 437 U.S. 267, 98 S.Ct. 2340, 57 L.Ed.2d 197 (1978); Champion International Corp. v. Bureau of Revenue, 88 N.M. 411, 540 P.2d 1300, 1307-08 (Ct.App. 1975) (Lopez, J., specially concurring). Second, under I.C. § 63-3027(a)(1) business income includes not only a corporation's typical earnings from its business activities but also income from tangible and intangible property if that property and income has the requisite connection with the corporation's trade or business. Prior to UDITPA most states did not apportion a multistate corporation's income from dividends, interest, royalties, rents and gains, but, with some exceptions, the states allocated that income to a single jurisdiction. See State Taxation of Interstate Commerce: Hearings Before the Subcomm. on State Taxation of Interstate Commerce of the Senate Comm. on Finance, 93rd Cong. 1st Sess. 246, 252-54 (1973) (prepared statement of James H. Peters, The Distinction Between Business Income and Non-Business Income). Indeed, a preliminary draft of the uniform act followed this general approach. See First Tent. Draft of Uniform Allocation and Apportionment of Income Act, §§ 4-9, reprinted in Brief for Amicus Curiae, United States Steel Corp., Exhibit A. However, the Act in its final form and as enacted in this state specifically includes income from the acquisition, management, or disposition of tangible and intangible property when such acquisition, management, or disposition constitute integral or necessary parts of the taxpayers' trade or business operations as business income. I.C. § 63-3027(a)(1). This break with prior practice is underscored by the Idaho version of the Act which contains the specific presumption that income from stock and securities of any foreign or domestic corporation is business income and which may be overcome only by clear and convincing evidence. I.C. § 63-3027(a)(1). In short, classifying income as interest, rents, royalties, dividends and capital gains does not determine whether the income is apportionable under UDITPA. All forms of income are subject to apportionment under UDITPA if the income falls within the definition of business income. Third, we do not understand the statutory requirement that the acquisition, management, or disposition of the underlying property be an integral or necessary part of the taxpayer's trade or business, I.C. § 63-3027(a)(1), to mean that the property must be an absolutely indispensable part of the taxpayer's business. In taxation statutes the word necessary is not generally given such a restrictive meaning. See, e.g., Welch v. Helvering, 290 U.S. 111, 54 S.Ct. 8, 78 L.Ed. 212 (1933) (expense deduction); Palo Alto Town & Country Village, Inc. v. Commissioner of Internal Revenue, 565 F.2d 1388 (9th Cir.1977) (expense deduction); Boy's Club of Clifton, Inc. v. Township of Jefferson, 72 N.J. 389, 371 A.2d 22 (1977) (exemption from property tax). Also, the word necessary was added to the uniform act by the Idaho legislature at the same time it added the presumption that income from stock and securities is business income. See ch. 254, § 1, 1965 Idaho Sess. Laws 639, 642-47. A very restrictive interpretation of integral or necessary would be inconsistent with the apparent legislative belief that income from securities would generally be business income. In our view the phrase integral or necessary parts of the taxpayers' trade or business operations refers to property which, though not absolutely essential to the conduct of the taxpayer's business, contributes to and is identifiable with the taxpayer's trade or business operations. Cf. Superior Oil Co. v. Franchise Tax Board, 60 Cal.2d 406, 34 Cal. Rptr. 545, 550, 386 P.2d 33, 38 (1963) (defining essential as used in test for unitary business). Although we do not read the phrase integral or necessary restrictively, our interpretation of that phrase is not as broad as that argued by the commission in this case. In a sense all investments and investment income of a corporation may benefit a corporation's business operations in that the investments may supply additional revenue for operating the trade or business, may improve the corporation's standing and financial posture, and in general may permit the corporation to conduct its regular business activities in a way it could not absent those investments. In this broad sense all corporate investments could be thought of as property the acquisition, management or disposition of which constitutes an integral or necessary part of its trade or business operations. This is the position argued by the commission. However, such an approach would include virtually all income as business income and would in effect emasculate the provisions of UDITPA which provide for the allocation of income from specified tangible and intangible property. See I.C. § 63-3027(d)-(h). Under such a test it is doubtful whether a corporation could receive income that would not be classified as business income. Although the legislature clearly intended that the income from tangible and intangible property be included as business income in proper circumstances, it likewise intended that there would continue to be such a thing as corporate non-business investment income. Just as we reject the notion that income from tangible or intangible property is to be automatically classified as non-business income, we reject the notion that such income is to be automatically considered business income simply because the taxpayer's business operations may receive some incidental benefits from those investments. [4] But see Montana Department of Revenue v. American Smelting & Refining Co., 567 P.2d 901, 907-08 (Mont. 1977), appeal dismissed 434 U.S. 1042, 98 S.Ct. 884, 54 L.Ed.2d 793 (1978). In our view, in order for such income to be properly classified as business income there must be a more direct relationship between the underlying asset and the taxpayer's trade or business. The incidental benefits from investments in general, such as enhanced credit standing and additional revenue, are not, in and of themselves, sufficient to bring the investment within the class of property the acquisition, management or disposition of which constitutes an integral part of the taxpayer's business operations. This view furthers the statutory policy of distinguishing that income which is truly derived from passive investments from income incidental to and connected with the taxpayer's business operations. Finally, the facts in this case are based substantially on a lengthy stipulation between the parties, and for the most part they are not disputed. The decisive issues concern the proper application of the Idaho version of UDITPA to these facts. Accordingly, the scope of our review, which is a review of questions of law, is substantially broader than in cases where we are reviewing issues which turn on the resolution of disputed facts. Montana Department of Revenue v. American Smelting & Refining Co., supra . See Wessells v. State, 562 P.2d 1042 (Alaska 1977); Walt Keeler Co. v. Atchison, Topeka & Santa Fe Ry. Co., 187 Kan. 125, 354 P.2d 368 (1960); Wendling v. Cundall, 568 P.2d 888 (Wyo. 1977); cf. Clements v. Clements, 91 Idaho 732, 430 P.2d 98 (1967) (absence of findings disregarded where facts clear from record). Also, most of the disputed items of income are [g]ains or losses and dividend and interest income from stock and securities of ... foreign or domestic corporation[s]. I.C. § 63-3027(a)(1). Such items of income are presumed to be from intangible property, the acquisition, management, or disposition of which constitute an integral part of the taxpayers' trade or business; and this presumption may be overcome only by clear and convincing evidence to the contrary. Id. Thus we must review the evidence to determine whether the trial court's findings contrary to that presumption are supported by clear and convincing evidence. See Ed Sparks & Sons v. Joe Campbell Constr. Co., 99 Idaho 139, 578 P.2d 681 (1978). With these principles in mind we turn now to the issues concerning the application of the business income definition to the items of income involved in this appeal. We discuss these issues in terms of the type of income involved. Dividends : With respect to the dividends involved here, the critical question is whether this income arose from ASARCO's business activities and whether ASARCO's acquisition, management or disposition of the underlying stock constitutes an integral or necessary part of its mining, smelting and refining business. The district court ruled that the commission erred in classifying the dividends as business income, stating: The next question is whether the dividends, interest, patent royalties and capital gains, together with rental income, were subject to tax by the State of Idaho as business income. The court has reviewed the facts and the authorities submitted by the parties and has concluded that they are not. American Smelting and Refining Company is in the business substantially of mining, smelting and refining and sales. The income described does not come from property or activities which is an integral part of taxpayer's trade or business. Plaintiff's position is well taken in that it would be unreasonable, unfair and contrary to the law to allow the State of Idaho to throw this income in to be taxed under the circumstances of this case without allowing the plaintiff to consider all of the income and all of the expenses of all of the corporations involved. It appears to the court that if the dividend income from other corporations is an integral part of the business of the plaintiff that they should be unitized and all matters considered and if they are not that the income is not business income but is non business income. The district court appears to have disapproved of the commission's action in including the dividends as business income for two reasons. First, the district court stated that it was an error to include this income without allowing [ASARCO] to consider all the income and all the expenses of all the corporations involved. Presumably the trial court was referring to the fact that the sales, payroll and property of the dividend-paying corporations were not represented in the three factor apportionment formula. We note, however, that although the statute clearly provides for the apportionment of dividend income when such income falls within the statutory definition of business income, it does not specifically provide for the representation of the sales, payroll and property of the dividend-paying corporations in the apportionment formula. See I.C. § 63-3027(j)-(r). The commission's apportionment of the dividends without including the factors of these corporations in the formula did not violate the statutory provisions. However, the commission's action does raise certain constitutional questions which we consider later in this opinion. Second, the district court seems to have concluded that since the corporations which paid the dividends were not sufficiently connected with ASARCO's business operations to justify combining those corporations with ASARCO for tax reporting purposes pursuant to I.C. § 63-3027(s), the stock ASARCO owned in those corporations was ipso facto not an integral or necessary part of ASARCO's trade or business so as to justify including the dividends they paid ASARCO as part of ASARCO's apportionable business income under I.C. § 63-3027(a)(1). When corporations are combined under subsection (s) for tax reporting purposes, the dividends paid one corporation by the other are not considered income but, as the commission did in this case, are properly treated as intracompany transfers. The district court's reasoning, therefore, would preclude dividends from ever being classified as business income and is thus clearly inconsistent with subsection (a)(1) which presumes that dividends are business income. The effect of this reasoning would nullify the statutory provision, a result we must avoid if possible. Magnuson v. Idaho State Tax Commission, 97 Idaho 917, 556 P.2d 1197 (1976). However, these provisions are not necessarily inconsistent. They have different objectives and they can be read harmoniously if those objectives are kept in mind. The combined reporting provision of subsection (s) is a further refinement of the basic apportionment principle. Its purpose is to permit application of the UDITPA formula to a single business enterprise which is conducted by means of separately incorporated entities. See United States Steel Corp. v. Multistate Tax Commission, 434 U.S. 452, 473, n. 25, 98 S.Ct. 799, 813, n. 25, 54 L.Ed.2d 682 (1978). In an economic sense such a business is no different than a similar business composed of a single corporation with several separate divisions. Compare Butler Bros. v. McColgan, supra , with Edison California Stores, Inc. v. McColgan, 30 Cal.2d 472, 183 P.2d 16 (1947). For tax reporting purposes such businesses should be treated the same. Coca Cola Co. v. Department of Revenue, 271 Or. 517, 533 P.2d 788 (1975); Keesling, A Current Look at the Combined Report and Uniform Allocation Practices, 42 J.Tax. 106 (1975). In contrast, subsection (a)(1), which authorizes the apportionment of a taxpayer's dividend income in certain circumstances, addresses a very different question. While the combined reporting provision concerns a proper identification of the contours of the business enterprise, the business income definition of subsection (a)(1) concerns the differentiation between truly passive investment income and income which is incidental to or connected with the taxpayer's business operations. These are two related but conceptually and legally very different questions. Simply because the management, operation and activity of a corporation in which the taxpayer owns stock is not so closely connected with the management, operation and activities of the taxpayer to warrant a combined tax return, does not ipso facto mean that the dividends the taxpayer receives from that stock cannot be income arising from transactions and activity in the regular course of the taxpayers' trade or business and that the acquisition, management, or disposition of the stock does not constitute integral or necessary parts of the taxpayers' trade or business operations. I.C. § 63-3027(a)(1). The combined reporting provision and the business income definition serve different purposes, ask different questions and apply different standards. The answer to one does not necessarily imply the same answer to the other. With respect to the dividends ASARCO received from Southern Peru Copper Corp.; M.I.M. Holdings, Ltd.; General Cable; Revere Copper; ASARCO Mexicana, S.A.; and Compania American Smelting, S.A., we conclude that the record does not contain clear and convincing evidence to rebut the statutory presumption and does not support the trial court's finding that those dividends were not business income. For the years in question ASARCO owned a controlling or at least a very substantial interest in each of these corporations. They are all engaged in businesses closely related to ASARCO's mining and smelting operations and, with the exception of M.I.M., ASARCO did a substantial amount of business with them and provided them with a variety of technical services. The clear inference from these facts is that ASARCO's interest in these companies was not merely that of a passive investor but that this dividend income arises from ASARCO's mining and smelting business and that ASARCO acquired and maintained its ownership interest in these companies as an integral and necessary part of its mining and smelting business. We recognize that M.I.M., for the years in question, seems to have operated independently of ASARCO and did little if any business with ASARCO. Although ASARCO owns a controlling interest in M.I.M., ASARCO did not exercise its right to control the corporation, apparently for political reasons. Nevertheless, ASARCO does own a majority of M.I.M. stock and M.I.M. is engaged in virtually the same business as ASARCO. Given these facts and the statutory presumption we conclude that the trial court erred in concluding that ASARCO's interest in M.I.M. was merely a passive investment unrelated to ASARCO's mining and smelting business. However, we conclude that there was clear and convincing evidence to sustain the trial court's finding that the dividends from Lake Asbestos, ASARCO Int., Hecla Mining Co., Kennecott Copper Co., Phelps-Dodge and United Park City Mines were not business income. Although the record indicates certain management connections between ASARCO and Lake Asbestos and ASARCO Intl., the record indicates that this asbestos mining and processing activity is distinct, separate and unrelated to ASARCO's general mining and smelting business. Regardless of whether the dividends these corporations paid ASARCO would have constituted business income with respect to an asbestos business, the record discloses that these asbestos operations have no connection with the trade or business ASARCO conducts. Therefore, that dividend income is not business income subject to apportionment by this state. See Sperry & Hutchinson Co. v. Department of Revenue, supra . The four remaining companies from which ASARCO received dividends are all engaged in mining activities similar to those pursued by ASARCO. Nevertheless, ASARCO's stock ownership in those companies is so small and its business dealings with them are so insignificant that, despite the statutory presumption, we conclude that the trial court's finding that ASARCO's ownership of that stock was more of a separate investment activity than a part of its trade or business operations is supported by the evidence. Therefore, the dividends these companies paid ASARCO should not have been included as business income. Interest : [5] In general, the source of ASARCO's interest income was customer notes and other obligations ASARCO received in the regular course of its mining and smelting operations. As such, they were therefore properly considered as business income by the commission, and the trial court's findings to the contrary are not supported by the evidence. See Montana Department of Revenue v. American Smelting & Refining Co., supra ; Sperry & Hutchinson Co. v. Department of Revenue, supra ; Champion International Corp. v. Bureau of Revenue, supra ; cf. Great Lakes Pipe Line Co. v. Commissioner of Taxation, 272 Minn. 403, 138 N.W.2d 612 (1965) (interpreting statute analogous to UDITPA), appeal dismissed 384 U.S. 718, 86 S.Ct. 1886, 16 L.Ed.2d 881 (1966). Rents : ASARCO's rental income was primarily derived from property used in or very closely related to its mining and smelting operations. Accordingly, the trial court erred in excluding rents from business income. I.C. § 63-3027(a)(1) and (d). See Montana Department of Revenue v. American Smelting & Refining Co., supra ; Champion International Corp. v. Bureau of Revenue, supra . Royalties : The record indicates that the assets generating ASARCO's royalty income were acquired or developed by ASARCO in the course of its regular business operations. This income was related to or a consequence of its business operations and was therefore properly considered business income by the commission. See Montana Department of Revenue v. American Smelting & Refining Co., supra ; cf. Texaco, Inc. v. Wasson, 237 S.E.2d 75 (S.C. 1977) (interpreting statute analogous to UDITPA). Capital gains and losses : As previously mentioned, ASARCO's capital gains and losses resulted from the disposition of three types of assets: fixed assets, short term notes and bonds, and securities. The fixed assets were used in ASARCO's everyday business activities and therefore gains realized on their disposition were business income. The trial court's finding to the contrary is not supported by the evidence. The notes and bonds represented the short term investment of idle funds until they were needed in ASARCO's ordinary business operations. Accordingly, the trial court erred in not considering the gains realized from the disposition of those notes and bonds as business income. See Montana Department of Revenue v. American Smelting & Refining Co., supra ; Sperry & Hutchinson Co. v. Department of Revenue, supra ; Champion International Corp. v. Bureau of Revenue, supra ; cf. Great Lakes Pipe Line Co. v. Commissioner of Taxation, supra . ASARCO also realized gains from the sale of stock in its subsidiaries and General Cable. In our view the same standard applies to the question whether gains from the sale of stock are business income as applies to the question whether dividends from the stock are business income. The focus of the inquiry should be upon the purpose and use of the stock by ASARCO prior to its disposition. See I.C. § 63-3027(a)(1); Montana Department of Revenue v. American Smelting & Refining Co., supra ; Champion International Corp. v. Bureau of Revenue, supra ; cf. Johns-Mansville Products Corp. v. Commissioner of Revenue Administration, 115 N.H. 428, 343 A.2d 221 (1975) (similar approach, but not interpreting UDITPA), appeal dismissed 423 U.S. 1069, 96 S.Ct. 851, 47 L.Ed.2d 79 (1976). Inasmuch as we have already concluded that the trial court's conclusion that ASARCO sustained its burden of proving by clear and convincing evidence that the dividends it received from this stock were not business income is not supported by the evidence, we similarly conclude that the trial court's conclusion that the gains and losses realized on the disposition of the stock were not business income is not supported by the record. Having resolved these issues concerning the items of ASARCO's income which are properly apportionable under the Idaho version of UDITPA, we consider now the constitutional questions.