Reach Out and Tax Someone
| Jurisdiction | Utah,United States |
| Citation | Vol. 8 No. 6 Pg. 12 |
| Pages | 12 |
| Publication year | 1995 |
June, 1995
State Taxation of Income from the Sale of Intangibles
Maxwell A. Miller and Randy M. Grimshaw, J.
AN OVERVIEW
The past decade has seen an increased trend in corporate "downsizing, " a process whereby corporations divest themselves of entire lines of business, whether to reduce debt, avoid hostile takeovers, move into other, more profitable lines of business or for other reasons. For example, in 1981 Bendix Corporation sold its 20.6% stock interest in ASARCO, Inc. for $211 million gain. In 1983, Jewel Companies, Inc. sold its 36% interest in Aurrera for a $3.7 million gain. In 1986, Hercules Incorporated sold its 13% interest in Erbamont for a $1.7 million gain. The same scenario frequently plays out throughout the United States.
Such transactions often generate significant capital gains, which states typically clamor to tax. If the corporation is domiciled in Utah and derives its income solely from Utah sources, it is easy to figure the corporate franchise tax on the corporation's Utah taxable income. It is 5% of the taxpayer's "adjusted income" (i.e., federal taxable income plus or minus state adjustments.) But that is almost never the case. If the corporation is not domiciled in Utah, conducts business in multiple jurisdictions, ' and derives gain from the sale of stock in a subsidiary engaged in a different line of business, legitimate state taxation of the gain becomes complex as the attached schematic shows.[1]
Utah may "apportion" or tax its fair share of "business income" of a multistate "unitary business" (one characterized by centralized management, functional integration and economies of scale) under Utah's version of the Uniform Division of Income for Tax Purposes Act ("UDITPA").[2] Under Utah State Tax Commission administrative rules, income, including gains, is presumptively business income deemed apportion-able, and deficiency assessments are presumptively correct.[3]
Consequently, taxpayers who dispute an audit deficiency must play on a decisively unlevel playing field. More like charging up a 45 degree incline, taxpayers must overcome the double presumption against them, almost always with no explanation from the Auditing Division as to the factual basis for its conclusions.[4]
Non-domiciliary corporate taxpayers frequently face at least two serious perils from states seeking to apportion their gain on the sale of intangible assets. First and foremost, states have been expanding the definition of business income to such extremes that there is no practical restraint on a state's power to reach beyond its borders and tax income having no operational link with business activities in the taxing state. It is as if the concept "nonbusiness income, " while yet codified in UDITPA, is non-existent, or has become, as a practical matter, a nullity. Second, assuming these gains are apportionable business income, states typically inflate income subject to taxation because they do not include the source of the income's apportionment factors in the denominator of the apportionment formula. In one case, for instance, 90% of the taxpayer's income for the year came from gain on its sale of stock in a subsidiary, but nowhere in the deficiency did the state give any consideration to any factors (i.e., the property, payroll or sales of the income source) that may have produced 90% of the corporate taxpayer's income. Both of these problems raise serious difficulties under the United States Constitution, which limits states from taxing income earned outside its borders, and mandates fair apportionment of multi-jurisdictional income.
This article will use a question-and-answer format in identifying the major issues and trends in UDITPA case law, and offer our personal view on arguments taken by the states and the taxpayers.
1. What is "business" and "nonbusiness" income?
UDITPA 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." Utah Code Ann. §59-7-302(2) (emphasis added). As an unhelpful, circular afterthought, UDITPA defines "nonbusiness income" as "all income other than business income." Utah Code Ann. §59-7-302(4).
Approximately half of the states have adopted UDITPA and many others have adopted variations of the act. State revenue departments have at times interpreted the definition of business income as encompassing anything which adds riches to the corporation. In other words, states argue in essence that all income is business income apportionable to the taxing state. As a result, there is not such thing as nonbusiness income, at least for non-domiciliary corporations.
For instance, in ASARCO Inc. v. Idaho State Tax Commission, 458 U.S. 307 (1982), Idaho argued that all...
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