ATTORNEYS FOR PETITIONER: ATTORNEYS FOR RESPONDENT:
FRANCINA A. DLOUHY STEVE CARTER
J. DANIEL OGREN ATTORNEY GENERAL OF INDIANA
BAKER & DANIELS Indianapolis, IN
VINCENT S. MIRKOV
DEPUTY ATTORNEY GENERAL
INDIANA TAX COURT
THE MAY DEPARTMENT STORES )
COMPANY, Successor in Merger with )
Associated Dry Goods Corporation, )
v. ) Cause No. 49T10-9906-TA-144
INDIANA DEPARTMENT OF STATE )
ON APPEAL FROM A FINAL DETERMINATION OF THE INDIANA
DEPARTMENT OF STATE REVENUE
May 7, 2001
Petitioner, The May Department Stores Company (May), successor in merger with Associated
Dry Goods Corporation (Associated), challenges the Indiana Department of State Revenues (Department) refusal
to refund May $384,424.03 in adjusted gross income tax, see Ind. Code Ann.
§ 6-3-2-1 (West 2000), supplemental net income tax, see I.C. § 6-3-8-1, and
interest for the tax year beginning February 1, 1986 and ending January 31,
1987. The income taxed was primarily generated by Associateds sale of the
assets comprising Joseph Horne Co. (Horne), a division of Associated. These gains
were initially classified by Associated as nonbusiness income, which under the circumstances made
them allocable outside of and nontaxable by Indiana. See I.C. § 6-3-1-21.
However, the Department reclassified the gains as business income, a move that
subjected the gains to apportionment and taxation by Indiana. See I.C. §
6-3-1-20. The issue for the Courts consideration is whether the gains were
business or nonbusiness income. To resolve this issue, the Court must decide
whether Indianas definition of business income requires that both a transactional test and
a functional test be applied in determining whether gains are business or nonbusiness
income. The Court considers this issue in the context of Mays motion
for summary judgment.
FACTS AND PROCEDURAL HISTORY
The facts are undisputed.
May is a New York corporation that is
qualified to do business in Indiana. Mays principal place of business and
commercial domicile is in St. Louis, Missouri. May is engaged in the
business of department store retailing. On October 4, 1986, May acquired all
of the stock of Associated, which was a Virginia corporation also engaged in
department store retailing. Associateds principal place of business and corporate headquarters was
in New York City, New York. Effective February 1, 1992, Associated was
merged into May.
Prior to its acquisition by May, Associated owned retail department stores throughout the
United States. These stores were grouped into divisions. Immediately prior to
its acquisition by May, Associated had nine divisions, including Horne.
divisions, Associated was engaged in the business of department store retailing, buying and
selling at retail clothing, apparel and accessories, home furnishings and related items.
(Manos Aff. ¶ 4.) Horne, which was not separately incorporated, operated twelve
store sites in Pennsylvania and four store sites in Ohio.
Adcor Realty Corporation (Adcor) was a wholly-owned subsidiary of Associated. It was
a New York corporation with its principal office in New York City, New
York. Adcor served as the holder of legal title to and other
interests in much of the real estate used by Horne as well as
Associateds other divisions. Like Associated, Adcor was merged into May effective February
May announced its intention to acquire Associated in 1986. At that time,
Kauffmans Department Store, a division of May, was conducting business in Pittsburgh, Pennsylvania.
Horne operated ten store sites in or near Pittsburgh. The City
of Pittsburgh feared that, after the proposed acquisition, May would monopolize the business
of department store retailing in the area. Therefore, prior to Mays acquisition
of Associated, an action against May and Associated by the City of Pittsburgh
and others was brought in the United States District Court for the Western
District of Pennsylvania; the plaintiffs alleged that the proposed acquisition would substantially lessen
competition and tend to create a monopoly in violation of Section 7 of
the Clayton Act. (Manos Aff. ¶ 10.)
The action was resolved by stipulation of the parties on September 24, 1986.
The Stipulation and Order (Order) required May to divest all of the
assets and interests of Horne.
(Manos Aff., Ex. A.) By the
Orders terms, May was obligated to take steps to open those stores of
Horne that had previously been scheduled for opening. Moreover, May was responsible
for maintaining Horne in good operating condition so that it could be divested
as a viable competitive entity. (Manos Aff., Ex. A.) One Horne
store site was sold by Associated on December 19, 1986. On December
29, 1986, all of Hornes remaining assets were sold by Associated. In
like manner, Adcor was required to sell any title to or interest in
real estate used by Horne that it held.
Associated and certain of its subsidiaries, including Adcor, filed a consolidated Indiana adjusted
gross income tax and supplemental income tax return for the tax year.
On that return, the gains from the sale of Hornes assets that were
realized by Associated and Adcor ($66,191,088) were reported as nonbusiness income. The
Department audited the consolidated return for the tax year. On October 5,
1990, the Department issued a proposed assessment of additional adjusted gross income and
supplemental net income tax against Associated and its affiliates. This assessment
was attributable to the Departments reclassification of the gain from the sale of
Hornes assets from nonbusiness income to business income.
On December 3, 1990, Associated protested the proposed assessment, and the Department thereafter
conducted a hearing on the protest. On April 28, 1993, the Department
issued a letter of findings denying Associateds protest. The Department issued a
final assessment for the tax year on June 25, 1993. May, as
successor in merger with Associated, paid the Department $384,424.03 ($247,555 in tax and
$136,896.03 in interest).
On June 14, 1996, May filed a refund claim for the tax year.
The Department has issued no final determination on this refund claim.
On June 11, 1999, May filed this original tax appeal. May filed
a motion for summary judgment on March 1, 2000. The Court conducted
a hearing on the motion on July 13, 2000. Additional facts will
be supplied where necessary.
ANALYSIS AND OPINION
Standard of Review
The Court hears appeals of refund claims de novo.
I.C. § 6-8.1-9-1(d).
Summary judgment is only appropriate where there is no genuine issue of
material fact and the moving party is entitled to summary judgment as a
matter of law. Ind. Trial Rule 56(C); Mynsberge v. Department of State Revenue,
716 N.E.2d 629, 631 (Ind. Tax Ct. 1999). Questions of statutory interpretation
are particularly amenable to resolution by summary judgment. Mynsberge, 716 N.E.2d at
The parties dispute the definition of business income. The issue before the
Court is one of first impression in Indiana, although it has been much
debated in other jurisdictions across the country. Pursuant to Ind.
Code § 6-3-1-20,
The term business income means income arising from transactions and activity in the
regular course of the taxpayers trade or business and includes income from tangible
and intangible property if the acquisition, management, and disposition of the property constitutes
integral parts of the taxpayers regular trade or business operations.
Nonbusiness income, in turn, means all income other than business income. I.C.
§ 6-3-1-21. The distinction between business and nonbusiness income is important in
calculating a taxpayers income tax liability. Indiana corporations pay the greater of
the gross income tax or adjusted gross income tax, plus the supplemental income
tax. Longmire v. Indiana Dept of State Revenue, 638 N.E.2d 894, 896
(Ind. Tax Ct. 1994) (citing I.C. § 6-3-3-2). Pursuant to Ind. Code
§ 6-3-2-2, for the purpose of calculating a corporations adjusted gross income tax
liability, business income is apportioned between Indiana and other states using a three-factor
while nonbusiness income is allocated to Indiana or another state.
corporations net income is its adjusted gross income, with certain adjustments. I.C.
§ 6-3-8-2(b). Thus, whether income is deemed business or nonbusiness income determines
whether it is allocated to a specific state or whether it is apportioned
between Indiana and other states wherein the taxpayer is conducting its trade or
business.I. Other Jurisdictions
Indianas definition of business income mirrors that found in the Uniform Division of
Income for Tax Purposes Act (UDITPA), although Indiana has not adopted UDITPA.
See Jerome R. Hellerstein & Walter Hellerstein, State Taxation ¶ 9.01 (Table 9-1)
(3d ed. 1998 & Supp. 2000) (listing states that have adopted UDITPA).
Drafted in the mid-1950s, UDITPA in part sought to promote uniformity in allocation
practices among the states that impose tax on or measured by the net
income of a corporation.
R. Crawford & R. Uzes, The Distinction
Between Business and Nonbusiness Income, The State & Local Tax Portfolio Series ¶
505.3 (1989 & Supp. 1994). See also Pledger v. Getty Oil Exploration
Co., 831 S.W.2d 121, 124 (Ark. 1992) (UDITPA is designed to fairly apportion
among the states in which a corporation does business the fair amount of
regular business income earned by the corporations activities in each state.); Hellerstein, supra
¶ 9.01 (stating [m]ost states have sought to discharge their constitutional obligation to
confine their corporate income taxes to income derived from the corporations activities in
the taxing state by adopting [UDIPTA] or a closely analogous statute). The
key features of UDITPA and the Indiana statute are the concepts of allocation
and apportionment. When income is allocated, it is attributed to the particular
state or states that are considered to be the source of the income.
. . . When income is apportioned, . . . it is
divided among the various states in which the taxpayer derives such apportionable income.
Hellerstein, supra ¶ 9.02. See also Roger Dean Enters., Inc. v.
Department of Revenue, 387 So. 2d 358, 361 (Fla. 1980) (explaining meanings of
allocation and apportionment and stating that the two are entirely separate, distinct, and
different concepts). Under UDIPTA and similar taxing regimes, all business income is
apportioned; all nonbusiness income is allocated.
Hellerstein, supra ¶ 9.02.
The Court will construe and interpret a statute only if it is unclear
and ambiguous. Shoup Buses, Inc. v. Indiana Dept of State Revenue, 635
N.E.2d 1165, 1167 (Ind. Tax Ct. 1994). When a statute is susceptible
to more than one interpretation, it is ambiguous. Amoco Prod. Co. v. Laird,
622 N.E.2d 912, 915 (Ind. 1993). Although a disagreement between the parties
does not necessarily indicate ambiguity, opposing interpretations are persuasive in suggesting that an
ambiguity exists. Shoup Buses, 635 N.E.2d at 1168. When construing
a statute, the Courts function is to give effect to the intent of
the General Assembly in enacting the statutory provision. Mynsberge, 716 N.E.2d at
632. Generally, the best evidence of that intent is found in the
language of the statute chosen by the General Assembly. Id. The
Court will strive to give words and phrases in a statute their plain,
ordinary and usual meaning. Uniden Am. Corp. v. Indiana Dept of State
Revenue, 718 N.E.2d 821, 824 (Ind. Tax Ct. 1999). Tax imposition statutes
are to be strictly construed against the imposition of the tax. Mynsberge,
716 N.E.2d at 633. However, the policy of strict construction will not
override the plain language of a tax imposition provision. Id. Further,
the Court must read a statute to give effect to every word.
USAir, Inc. v. Indiana Dept of State Revenue, 623 N.E.2d 466, 470 (Ind.
Tax Ct. 1993). The Court will strive to avoid an interpretation that
renders any part of the statute meaningless or superfluous. Id. at 469;
Mynsberge, 716 N.E.2d at 633.
Courts in other states have applied differing interpretations to the business income definition.
Although not binding on this Court, the decisions from other states are
instructive. USAir, Inc., 623 N.E.2d at 469 n.4. Some courts have
found that the business income definition includes both a transactional and a functional
test; other courts have construed the business income definition as providing for only
a transactional test. Hellerstein, supra ¶ 9.05 (listing in footnotes 101 &
102 cases adopting one or both tests). The differing interpretations arise from
the imprecise language and awkward structure used to define business income.
A. Transactional Test
Those jurisdictions supporting only the transactional test rely upon the first part of
the definition, i.e., business income means income arising from transactions and activity in
the regular course of the taxpayers trade or business. I.C. § 6-3-1-20.
Under the transactional test, the controlling factor by which business income
is identified is the nature of the particular transaction giving rise to the
income. General Care Corp. v. Olsen, 705 S.W.2d 642, 644 (Tenn. 1986)
(internal quotations and brackets removed). In deciding whether a specific transaction generated
business income, pertinent considerations include: (1) the frequency and regularity of similar
transactions; (2) the former practices of the business; and (3) the taxpayers subsequent
use of the income. Id. Accord Polaroid Corp. v. Offerman, 507
S.E.2d 284, 289 (N.C. 1998), cert. denied, 526 U.S. 1098, 119 S. Ct.
1576, 143 L. Ed. 2d 671 (1999). See also Western Natural Gas
Co. v. McDonald, 446 P.2d 781, 783 (Kan. 1968) (The controlling factor by
which the statute identifies business income is the nature of the particular transaction
giving rise to the income. To be business income the transaction and
activity must have been in the regular course of taxpayers business operations.); In
re Kroger, 12 P.3d 889, 893 (Kan. 2000) (same); Phillips Petroleum Co. v.
Iowa Dept of Revenue and Fin., 511 N.W.2d 608, 610-11 (Iowa 1994) (stating
that test for identifying business income is basically transactional and concluding that gains
from taxpayers sale of assets constituted nonbusiness income, where disposition of assets was
irregular in its scope and nature).
The Alabama Supreme Court recently concluded that the business income definition contained only
the transactional test. Ex parte Uniroyal Tire Co., 779 So. 2d 227,
238 (Ala. 2000). In Ex parte Uniroyal Tire Co., the Uniroyal Tire
Company (Uniroyal) entered into a partnership with B.F. Goodrich Company. Thereafter, Uniroyals
only asset was its partnership interest; income from the partnership was treated as
business income. In 1990, Uniroyal sold its entire partnership interest, realizing a gain
of approximately 99.7 million dollars. On its 1990 Alabama tax return, Uniroyal
treated the gain as nonbusiness income. The State Department of Revenue disagreed,
maintaining that the income was business income and assessing corporate income tax accordingly.
The Alabama Supreme Court first observed that the word and in the phrase
acquisition, management, and disposition of the property was conjunctive, not disjunctive. Id.
at 233. According to the Alabama Supreme Court, reading the word or
in place of and would allow the statute to be construed so broadly
as to eclipse entirely the transactional test. Id. at 235. The
functional test, the Court pointed out, would essentially render nugatory the transactional test.
Id. The Court then noted that the legislature would not be
presumed to have enacted a futile, meaningless statute. Id. at 236.
The Alabama Supreme Court posited that the complete liquidation and cessation of business
do[es] not generate business income under the transactional test, because such events do
not take place in the regular course of the taxpayers business. Id.
The Court explained that: Simply stated, Uniroyal was not in business
to go out of business. Going out of business is not a
regular business activity. Id. at 237. Thus, Uniroyals gain was found
to be nonbusiness income. Id. at 238.
B. Functional Test
Those jurisdictions supporting a functional test, in addition to the transactional test, rely
upon the second part of the definition, i.e., business income includes income from
tangible and intangible property if the acquisition, management, and disposition of the property
constitutes integral parts of the taxpayers regular trade or business operations. I.C. §
6-3-1-20. As described by one court, under the functional test, all gain
from the disposition of a capital asset is considered business income if the
asset disposed of was used by the taxpayer in its regular trade or
business operations. . . . Under the functional test, . . .
the extraordinary nature or infrequency of the sale is irrelevant. Texaco-Cities
Serv. Pipeline Co. v. McGaw, 695 N.E.2d 481, 484-85 (Ill. 1998) (citations omitted).
See also District of Columbia v. Pierce Assocs., Inc., 462 A.2d 1129,
1131 (D.C. 1983) (If the property had an integral function in the taxpayers
unitary business, its income properly can be apportioned and taxed as business income,
even though the transaction itself does not reflect the taxpayers normal trade or
In an opinion issued November 17, 2000, the Oregon Supreme Court concluded that
the states business income definition supported both a transactional and functional test.
In Williamette Indus., Inc., & Subsidiaries v. Department of Revenue, 15 P.3d 18
(Or. 2000), Williamette and its two subsidiaries received net oil and gas royalty
income from unrelated companies drilling on parts of their timberlands in Louisiana, Arkansas
and Oregon. The taxpayers allocated the royalties to the states where the
timberland was located. The Department of Revenue determined that the receipt of
royalties was business income, because it occurred as part of the taxpayers regular
Examining the statutory definition of business income,
the Oregon Supreme Court recognized the
presence of two tests in the statute, a transactional and functional test.
Id. at 21 (citing Simpson Timber Co. v. Department of Revenue, 953 P.2d
366 (Or. 1996)). In so doing, the Court stated,
The transactional test posits that business income arises from transactions in the regular
course of the taxpayers business. By contrast, the functional test dictates that
acquisition, management, use or rental, and disposition of property must constitute integral parts
of regular business operations. Under the functional test, income includes, for example,
royalty income if the acquisition, management, use or rental, and disposition of the
property that produces the royalty [are] also an integral part of the taxpayers
regular business operations.
Id. First, the Court determined that the royalties at issue did not
constitute business income under the transactional test. Id. at 22.
The Court reasoned that the taxpayers business was growing timber and making wood
products, not producing oil and gas. Id. Therefore, [r]eceiving royalties on
mineral rights was not in the regular course of taxpayers business as a
forest products company. Id. II. Indiana
Second, the Court held that, under the functional test, the royalty income was
not business income. Id. According to the Court, the functional test
addresses transactions involving property, more specifically, the property of businesses that sell or
otherwise dispose of property. Id. In the case at bar, there
was no disposition of the land that contained the minerals, so the taxpayers
could not fulfill the statutory element of a disposition as required under the
functional test. Id. Even viewing the minerals alone as the property,
the Court maintained that trading in minerals was not an integral part of
the business of manufacturing forest products. Id. Accordingly, the Court stated
that the evidence showed that it was not essential to the taxpayers business
that taxpayers own[ed] the underlying mineral rights to their timber lands. Id.
Thus, the acquisition, management, use or rental, and disposition of the
minerals were not integral to the taxpayers regular business operations of harvesting timber
and making forest products. Id. Consequently, the Court concluded that the
royalties were not business income as defined by the statute. Id.
See also Laurel Pipe Line Co. v. Commonwealth, 642 A.2d 472, 475-77 (Pa.
1994) (concluding that taxpayers sale of idle pipeline was nonbusiness income, where pipeline
was not disposed of as an integral part of taxpayers regular trade or
business and the effect of the sale was that the company liquidated a
portion of its assets).
At first blush, Indianas definition of business income is ambiguous. The above
cases involve similar definitions of business income, which are essentially UDITPAs definition.
They demonstrate that the definition of business income is susceptible to more than
one interpretation. As written, Ind. Code § 6-3-1-20 could be reasonably interpreted
as providing for only the transactional test or for both the transactional and
functional tests. Therefore, the Court will construe and interpret this section.
The Court examines the language and structure used in the statute. Both
parties contend that the plain language of Ind. Code § 6-3-1-20 supports their
respective positions. May argues that the word and is conjunctive and that
the words and includes are words of limitation, so that the words following
and includes limit or further explain the first part of the definition of
business income ending with income arising from transactions and activity in the regular
course of the taxpayers business. May asserts that the definitions two parts
must be read together as one single, coherent definition. (Petr Br. at
12.) According to May, had the General Assembly intended to have two
tests, it could have used the word or to connect the first and
second parts or, more definitively, used two separate sentences. Further, to support
its position that the words and includes are words of limitation, May relies
upon the Indiana Supreme Courts decision in Department of Treasury of Indiana v.
Muessel, 218 Ind. 250, 32 N.E.2d 596, 598 (1941), where the Court observed
that the word including ordinarily is viewed as a term of limitation.
The Department counters that in ordinary use and is used to conjoin two
words, clauses or sentences, so that as used in Ind. Code § 6-3-1-20,
and is joining two independent clauses and means that income includes that described
in the first clause as well as that described in the second clause.
(Respt Br. at 5.)
The plain, ordinary and usual meaning of a word is usually found in
a dictionary. Precedent v. State Bd. of Tax Commrs, 659 N.E.2d 701,
705 (Ind. Tax Ct. 1995). And is defined in Blacks Law Dictionary
56 (6th ed. abridged 1991) as A conjunction connecting words or phrases expressing
the idea that the latter is to be added to or taken along
with the first. Added to; together with; joined with; as well as;
including. Sometimes construed as or. As one Indiana Court of Appeals
case asserts, the word and is used to join sentence elements of the
same grammatical rank or function. Scott v. Marshall County Bd. of Zoning
Appeals, 696 N.E.2d 884, 886 (Ind. Ct. App. 1998) (quoting Websters Collegiate Dictionary
(10th ed. 1995)). Accord Hooper et al., Essentials of English 34 (1990)
(identifying and as a coordinating conjunction that join[s] sentence elements of equal importance).
Considered alone, the word and as used in Ind. Code §
6-3-1-20 to separate the two parts of the business income definition does not
clearly support recognition of either a single transactional test or for both a
transactional and functional test.
However, the Court does not consider use of the word and alone; rather
the Court looks at all the words in the business income definition.
First, the Court considers the word includes. May argues that includes has
the same meaning as the word including. The Indiana Supreme Court, in
Muessel, 32 N.E.2d at 598, viewed the term including as a term of
limitation. In Muessel, the issue was whether the redistribution of stock by
a holding company to the original owners of the stock constituted taxable income
to the owners under the Gross Income Tax Law of 1933. The
statute in question defined gross income in part as all receipts by reason
of the investment of capital, including interest, discount, rentals, royalties, fees, commissions or
other emoluments, however designated. Muessel, 32 N.E.2d at 597 (emphasis added).
The state contended that the receipt of stock constituted receipts by reason of
investment of capital. Id. The Court viewed the term including as
ordinarily a word of limitation. Id. at 598. That being so,
the words interest, discount, rentals, royalties, fees, commissions or other emoluments, however designated
identified the type of receipts from the investment of capital which the legislature
intended to tax by this provision, namely, all types of profits or earnings.
Id. As used in the gross income tax statute, including meant
the same as the words such as. Id.
The structure of the statute at issue in Muessel is different than the
structure of Ind. Code § 6-3-1-20. The gross income definition found in
Muessel uses the participle including to introduce a modifying phrase that limits the
noun phrase all receipts by reason of the investment of capital. In
contrast, Ind. Code § 6-3-1-20 has a subject, business income, and a compound
verb, means and includes. The difference in the two statutes structures is
significant. Including is part of a modifying phrase. As such, it
has less weight or importance within the sentence than do the verbs means
and includes. These verbs indicate that a meaningful statement or explanation follows.
See Hopper et al., supra at 14 (stating that finite verbs work
with subjects of sentences to give a sense of completeness). Here, definitional
noun phrases follow these two verbs. It would be unreasonable and illogical
to equate including, as used in the gross income tax statute at issue
in Muessel, with the word includes as used in Ind. Code § 6-3-1-20.
Consequently, Muessel does not support Mays contention that includes is a word
To read Ind. Code § 6-3-1-20 as having a single definition of business
income ignores the statutes use of the compound verb means and includes.
Within the business income definition, these verbs have equal importance. The noun
phrases following both verbs describe what constitutes business income. Mays interpretation of
business income would essentially erase the noun phrase following includes by ignoring its
distinct definitional language. The Court will read a statute in a way
that gives effect to every word within the statute and will strive to
avoid an interpretation that renders part of the statute meaningless or superfluous.
Therefore, the Court finds that, in passing Ind. Code § 6-3-1-20, the General
Assembly provided two tests for defining business income. See Polaroid Corp., 507 S.E.2d
at 290-91 (explaining that structure of definition and legislatures use of different language
between two parts of definition supported two distinct tests for business income).
As do other jurisdictions, the Court will refer to these as the transactional
and functional tests.
Having decided that two tests are provided for, the Court will examine
whether the gains generated by Associateds sale of Hornes assets met either test.
The sale of Horne liquidated the assets of an entire division of
Associated. Selling an entire division was not a regular business practice of
Associated. See Phillips Petroleum Co., 511 N.W.2d at 611 (holding that transactional
test was not met because the sale of corporations assets did not occur
in the regular course of [taxpayers] business). In other words, Associated was
not in business to sell off entire divisions. See Pledger, 831 S.W.
2d at 125 (concluding that transfer of promissory note to taxpayer was an
extraordinary and non-recurring event that was not a transaction that occurred in the
regular course of the taxpayers business). The transactional test has not been
met in the present case.
The Department briefly argues that the transactional test has been met. The
Department asserts that the sale of Hornes assets was not an unforeseen event,
that May knew that it would have to divest itself of Hornes assets
at the time it purchased Associated and therefore the sale of Hornes assets
was planned as part of [Mays] regular business activity.
(Respt Br. at
The Departments own regulation states that the critical element in determining whether income
is business income or nonbusiness income is the identification of the transactions and
activity which are the elements of a particular trade or business. 45
I.A.C. 3.1-1-29. In determining the scope of a taxpayers trade or business,
the Department looks to various factors. One factor to examine is the
frequency, number, or continuity of the activities and transactions involved.
3.1-1-30. There is no question that the sale of Hornes assets was
planned, as the Department indicates. However, the planned transaction was a one-time
event, where Associated liquidated the assets of a distinct and separate business division.
Associated was in the business of department store retailing, not buying and
selling the assets of entire divisions. This was an extraordinary transaction that
fell beyond the scope of even the Departments regulations defining a taxpayers trade
or business. Associateds gains did not qualify as business income under the
transactional test. Cf. Phillips Petroleum Co., 511 N.W.2d at 611 (concluding that
transactional test was not met, where a complete liquidation of corporations assets did
not take place but where enormity of the disposition was . . .
a once-in-a-corporate-lifetime occurrence).
The Court next examines whether the sale of Hornes assets met the functional
test. The functional test focuses on the property being disposed of by
the taxpayer. See Williamette Indus., 15 P.3d at 22. Specifically, the
functional test requires the Court to examine the relationship of the property at
issue with the business operations of the taxpayer. See Texaco-Cities Serv. Pipeline,
695 N.E.2d at 486 (noting that the reach of the [functional test] is
. . . directed towards the use or disposition of the property as
forming an integral part of the taxpayers business). By the very terms
of the statute, the acquisition, management, and disposition of the property generating income
must constitute an integral part of the taxpayers regular trade or business operations.
I.C. § 6-3-1-20. Thus, the property at issue must have been
acquired, managed and divested or disposed of by the taxpayer. More importantly,
this process (i.e., acquisition, management and disposition) must be integral to the taxpayers
regular trade or business operations. It is not enough that the property
was used to generate business income for the taxpayer prior to its disposition.
The disposition too must be an integral part of the taxpayers regular
trade or business operations.
The term integral may be defined as part or constituent component necessary or
essential to complete the whole. Blacks Law Dictionary 558 (6th ed. abridged
1991). See also Texaco-Cities Serv. Pipeline, 695 N.E.2d at 485 (noting that
integral in part means essential to completeness). Accord Polaroid Corp., 507 S.E.2d
at 292. Under the functional test, the frequency of the transaction generating
gain is not a key consideration. Texaco-Cities Serv. Pipeline, 695 N.E.2d at
485 (citing Ross-Araco v. Commonwealth of Pa., Bd. of Finance & Revenue, 674
A.2d 691, 693 (Pa. 1996)). Thus, even though Associateds sale
of Hornes assets was an uncommon transaction in the course of its regular
trade or business operations, the gains from that transaction could theoretically be classified
as business income. However, it will only be viewed as business income
if the acquisition, management and disposition of Hornes assets can be considered necessary
or essential to Associateds regular trade or business operations. See id. (observing
that the sale of property will constitute business income if the property and
sale are essential to the taxpayers business operations).
It was not. Associated, through all of its divisions, including Horne, was
engaged in the business of department store retailing. The disposition of Hornes
assets was neither a necessary nor an essential part of Associateds department store
retailing business operations. Horne was unquestionably an integral part of Associateds business
operations. Indeed, Horne was being expanded at the time May acquired Associateds
stock. However, pursuant to the Order, the divestiture of Hornes assets was
for the benefit of a competitor and not for the benefit of Associated.
Under these circumstances, this divesture (or disposition of assets) could not have
constituted an integral part of Associateds regular trade or business operations. See
Laurel Pipe Line Co., 642 A.2d at 475 & 476 (citing McVean &
Barlow, Inc. v. New Mexico Bureau of Revenue, 543 P.2d 489 (N.M. Ct.
App. 1975), cert. denied)). Therefore, the gains from the sale of Hornes
assets did not qualify as business income under the functional test.
The language and structure of Ind. Code § 6-3-1-20 supports the conclusion that
the General Assembly intended to define business income via application of both a
transactional and functional test. The Court agrees with the Oregon Supreme Court
that the functional test requires that the disposition of the assets at issue
must, along with their acquisition and management, constitute an integral part of the
taxpayers regular trade or business operations. Williamette Indus., 15 P.3d at 22.
In the present case, Associated divested an entire division for the benefit
of a competitor pursuant to a court order. This divestiture was not
an essential part of its department store retailing operations. Furthermore, the Court
disagrees with the Alabama Supreme Court that recognition of the functional test renders
the transactional test language futile. See Ex parte Uniroyal Tire Co., 779
So. 2d at 235.
Neither the transactional nor the functional test was met in the present case.
Therefore, the Court concludes that the gains received by Associated from the
sale of Hornes assets did not qualify as business income. Rather, the
gains must be considered nonbusiness income. Accordingly, the Departments refusal to grant
Mays requested refund was erroneous. As a matter of law, May, as
successor in merger with Associated, was entitled to a refund of all tax
and interest paid to the Department as a result of the Departments reclassification
of Associateds gains from nonbusiness to business income. Mays motion for summary judgment
is GRANTED. This matter is REMANDED to the Department with instructions to
calculate the refund, with statutory interest, due May.
The facts are drawn primarily from the Affidavits of John M. Manos
and Ron W. Saettele. Manos was Senior Counsel and Assistant Secretary for
May and had previously been employed by Associated. Saettele was the Director
of State & Local Taxes for May.
Footnote: The other eight divisions included the following: L.S. Ayres and Co.,
Lord & Taylor, J.W. Robinson Co., Sibley, Lindsay & Curr Co., The Denver
Dry Goods Co., Goldwaters, Hahne & Co., and Robinsons of Florida.
Footnote: The Order required May to divest the assets of Horne. However,
infra, Associated actually divested Hornes assets in 1986, not May.
Associated did not merge into May until 1992. Associated earned the income
from the sale of Hornes assets, and it is this income that the
Department taxed. May is prosecuting this original tax appeal as the successor
in merger with Associated. Therefore, the Courts analysis will focus on how
the divesture of Hornes assets relates with Associateds business operations and not those
The Court has jurisdiction to hear an original tax appeal where, as
in the present case, the taxpayer has waited at least 181 days (and
less than three years) but has received no determination from the Department regarding
[its] claim for refund.
City Secs. Corp. v. Department of State Revenue, 704
N.E.2d 1122, 1125 (Ind. Tax Ct. 1998) (citing I.C. § 6-8.1-9-1(c)).
The three-factor formula is found at
Ind. Code § 6-3-2-2(b), which provides
[I]f business income of a corporation . . . is derived from sources
within the state of Indiana and from sources without the state of Indiana,
then the business income derived from sources within this state shall be determined
by multiplying the business income from sources both within and without the state
of Indiana by a fraction, the numerator of which is the property factor
plus the payroll factor plus the sales factor, and the denominator of which
is three (3).
Effective January 1, 1992, the Indiana General Assembly changed the method of formulary
apportionment to phase in a double weight sales factor. Hunt Corp. v.
Department of State Revenue, 709 N.E.2d 766, 772 n.13 (Ind. Tax Ct. 1999)
(citing I.C. § 6-3-2-2(b)). The property, payroll and sales factors are further
explained by Ind. Code §§ 6-3-2-2(c)-(e). See also Container Corp. of Am.
v. Franchise Tax Bd., 463 U.S. 159, 170, 103 S. Ct. 2933, 2943,
77 L. Ed. 2d 545 (1983) (observing that the three-factor formula . .
. has become . . . something of a benchmark against which other
apportionment formulas are judged); Sherwin-Williams v. Indiana Dept of State Revenue, 673 N.E.2d
849, 851 (Ind. Tax Ct. 1996) (stating that Indiana has adopted a standard
form apportionment method); Jerome R. Hellerstein & Walter Hellerstein, State Taxation ¶ 9.02
(3d ed. 1998 & Supp. 2000) (observing that under the three-factor formula, a
taxpayers income is attributed to the state on the basis of a percentage
determined by averaging the ratios of the taxpayers property, payroll, and sales within
the state to its property, payroll, and sales everywhere).
Indianas allocation rules are based on the commercial domicile of the corporation
and the business situs of the income producing activity.
Hunt Corp., 709
N.E.2d at 771. See also I.C. §§ 6-3-2-2(g) to -2(k) (allocation
rules); Polaroid Corp. v. Offerman, 507 S.E.2d 284, 288 (N.C. 1998), cert. denied,
526 U.S. 1098, 119 S. Ct. 1576, 143 L. Ed. 2d 671 (1999)
(observing that nonbusiness income 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).
Similarly, the Multistate Tax Compact was developed in 1967 to promote uniformity
in the taxation of multistate businesses.
Hellerstein, supra ¶ 9.05[a] n.89.
See also Polaroid Corp., 507 S.E.2d at 288 (The Compact was created to
promote uniformity and compatibility in significant components of state tax systems and to
avoid duplicative taxation.). The Multistate Tax Commission is the administrative agency of
the Compact. Hellerstein, supra ¶ 9.05[a] One of the Commissions central goals
is to promote uniformity in the states taxation of interstate and foreign commerce.
Poloroid Corp., 507 S.E.2d at 288. The Commission is authorized by
the Compact to adopt uniform regulations relating to Article IV of the Compact,
which embodies UDIPTA. Hellerstein, supra ¶ 9.05[a] n.90. A number of
jurisdictions have enacted UDIPTA by becoming parties to the Compact. Id., ¶
9.01 (Table 9-2) (listing states, as well as District of Columbia, where Compact
has been adopted). Moreover, several jurisdictions have adopted the Commissions regulations in
whole or in part. Id. (Table 9-4) (listing states that have adopted
Commissions regulations). The [Commissions] regulations construe UDIPTA as establishing a presumption in
favor of apportionment. Id., ¶ 9.05[a]. Indiana has neither joined the
Compact nor adopted the Commissions regulations. Thus, the Commissions regulations are not
binding on this Court. See id., ¶ 9.05[a] (noting that regulations have
no legal force in any state unless that state adopts the regulations in
accordance with its own rulemaking process). Cf. Benham v. State, 637 N.E.2d
133, 137 n.3 (Ind. 1994) (rejecting use of commentary of Indianas penal code,
where there was no evidence . . . that it was adopted or
even considered by the legislature).
There are constitutional limitations on what income may be deemed as
part of a taxpayers apportionable base.
Hunt v. Department of Revenue, 709
N.E.2d 766, 770 (Ind. Tax Ct. 1999) (citing Container Corp., 463 U.S. at
165-66, 103 S. Ct. at 2940-41). These limitations arise from the unitary
business principle. Id. As explained in Hellerstein, supra ¶ 8.07,
Under the unitary business principle, if a taxpayer is carrying on a single
unitary business within and without the state, the state has the requisite connection
to the out-of-state activities of business to justify inclusion in the taxpayers apportionable
tax base of all the property, income, or receipts attributable to the combined
effect of the out-of-state and in-state activities. By the same token, if
the taxpayers activities carried on within the state are not unitary with its
activities carried on elsewhere, the state is constitutionally constrained from including the property,
income, or receipts arising from those out-of-state activities in the taxpayers apportionable tax
Accord Hunt Corp., 709 N.E.2d at 770. See also I.C. § 6-5.5-1-18
(defining unitary business and presuming that unity is present where there is unity
of ownership, operation, and use). As the United States Supreme Court has
noted, the linchpin of apportionability in the field of state income taxation is
the unitary-business principle. Mobile Oil Corp. v. Commissioner of Taxes of Vt.,
445 U.S. 425, 439, 100 S. Ct. 1223, 1232, 63 L. Ed. 2d
510 (1980). See also Allied-Signal, Inc. v. Director, Div. of Taxation, 504
U.S. 768, 778-83, 112 S. Ct. 2251, 2258-61, 119 L. Ed. 2d 533
(1992) (summarizing unitary-business principles development). See generally Franklin C. Latcham, Definition of
a Unitary Business, The State & Local Tax Portfolio Series ¶¶ 100-120 (1989
& Supp. 1994) (discussing development and standards for application of unitary business principle
and noting that the concept . . . is vital to the application
of formulary apportionment and is an important consideration in resolving the issue of
The Department classified the gains from the sale of Hornes assets as business
income. Thus, the Department found that Associated and Horne engaged in a
unitary business operation. See Hunt Corp., 709 N.E.2d at 777. May,
the successor in merger with Associated, does not dispute this conclusion. Absent
affirmative representations by either party, the Court will not presume that a dispute
exists on this point. See id.
Oregons definition of business income is slightly different than Indianas; it includes
income from tangible and intangible property if the acquisition, the management,
rental, and the disposition of the property constitute integral parts of the taxpayers
regular trade or business operations. Or. Rev. Stat. § 314.610(1) (emphasis added).
This difference has no impact on the Courts analysis.
The Department contends that its regulation supports both a transactional and functional
test. The Departments regulation
provides in part that business income is
income from transactions and activity in the regular course of the taxpayers trade
or business, including income from tangible and intangible property if the acquisition, management,
or disposition of the property are integral parts of the taxpayers regular trade
or business. Ind. Admin. Code tit. 45, r. 3.1-1-29 (1996) (emphasis added).
As discussed supra, the Indiana Supreme Court generally considers including a term
of limitation. Therefore, the Departments regulation seems to recognize only the transactional
test. The Court will give deference to an agencys interpretation of its
own regulation, unless its interpretation would be inconsistent with the regulation. State
Bd. of Tax Commrs v. Two Market Square Assocs. Ltd. Partnership, 679 N.E.2d
882, 886 (Ind. 1997). In this case, the Departments interpretation is
inconsistent with its own regulation. Moreover, recognition of only the transactional test
would run counter to legislative intent as evidenced by the language and structure
of Ind. Code § 6-3-1-20. The Department may not adopt a regulation
that is out of harmony with a statutory provision. Department of State
Revenue, Inheritance Tax Div. v. Estate of Hardy, 703 N.E.2d 705, 709 (Ind.
Tax Ct. 1998). To the extent it adopts only a transactional test,
Ind. Admin. Code tit. 45, r. 3.1-1-29 is invalid.
The Court notes that this regulation also appears defective in that it includes
a taxpayers income from property where the acquisition, management, or disposition of the
property is an integral part of the taxpayers regular trade or business.
45 I.A.C. 3.1-1-29. As discussed infra, Ind. Code § 6-3-1-20 requires that
not only the propertys disposition but also its acquisition and management must be
integral parts of the taxpayers regular trade or business. To the extent
the Departments use of or means that not all three actions (i.e., acquisition,
management and disposition) must be taken with respect to the property divested or
disposed of, the Departments regulation improperly expands the statutes meaning. See C
& C Oil Co., Inc. v. Indiana Dept of State Revenue, 570 N.E.2d
1376, 1381 (Ind. Tax Ct. 1991) (The Department cannot, however, enlarge or vary
by its rules and regulations the power conferred on it by the legislature.).
In referencing the gains from the sale of Hornes assets, the Court
also includes the gains generated by Adcors sale of title to or interest
in real estate used by Horne.
Footnote: The Department also contends that, because Horne generated business income prior to
its sale, the sale of Hornes assets should likewise be deemed to generate
business income. This argument is misplaced, as it is actually based upon
the functional test. With this argument, the Department improperly looks to the
use of Hornes divested assets prior to their sale as a determining factor
instead of examining the nature of the transaction in which the assets were
See General Care Corp., 705 S.W.2d at 644.
As provided by
Ind. Admin. Code tit. 45, r. 3.1-1-30, the Department
also considers the following in determining the scope of a taxpayers trade or
business: (1) the nature of the taxpayers trade or business; (2) the
substantiality of the income derived from activities and transactions and the percentage that
income is of the taxpayers total income for a given tax period; (3)
the length of time the property producing income was owned by the taxpayer;
and (4) the taxpayers purpose in acquiring and holding the property producing income.
The Departments argument on this point should focus on the regular trade
and business activities of Associated, which sold Hornes assets and earned the income
at issuenot that of May, which was the successor in merger with Associated.
Footnote: As evidenced by the conflicting opinions of jurisdictions interpreting the UDITPA-based definition
of business income, the definition is not a model of clarity. The
General Assembly is in the best position to remedy this problem. As
observed by the Alabama Supreme Court, legislatures in three states (Tennessee, New Mexico
and Iowa) responded to court opinions failing to recognize a functional test by
amending their definitions of business income.
Ex parte Uniroyal Tire Co., 779
So. 2d at 235. Moreover, the Court further notes that North Carolinas
Supreme Court, in Polaroid Corp. v. Offerman, interpreted the states definition of business
income, which read in part acquisition, management, and/or disposition of the property, as
being slightly broader than the definition found under [UDITPA]. 507 S.E.2d 284,
288 n.3 (N.C. 1998).