Was gain from selling a Georgia apartment complex nonbusiness income allocable entirely outside Florida, or business income subject to Florida apportionment?

Plain-English summary

Florida treated the capital gain from selling the Georgia apartment complex as business income subject to formulary apportionment, not nonbusiness income allocable entirely to Georgia.

The Department found a unitary relationship between the affiliated group's commercial-finance operation and its apartment ownership, management, and operation. The parent-side corporations controlled the real-estate entities, repeatedly made or guaranteed loans for their properties, and provided financial direction and capital-acquisition support. The real estate, in turn, supplied collateral and income for those loans.

The Georgia property also was not isolated from the Florida apartment operations. The complexes were held through controlled partnerships, managed through the affiliated group, and depended too heavily on common resources, services, and employees for the Department to treat the Georgia operation as a separate investment business.

Changing the holding structure shortly before the sale did not change the result. Contributing the properties to a second-tier partnership left the Georgia complex under the taxpayer's indirect control and did not break the flow of value within the affiliated business.

What this means for you

Multistate real-estate and finance groups

An out-of-state property's location does not by itself make the sale gain nonbusiness income. Florida looked at operational connections, control, financing, management, shared resources, and the economic relationship among the entities.

Corporate tax departments

Document whether intercompany loans and guarantees are passive investments or recurring operational tools. Here they financed the acquisition, expansion, and operation of controlled real-estate interests, supporting apportionment.

Accountants and tax professionals

Entity form was not decisive. The Department applied the unitary-business analysis across corporations and partnerships and focused on the underlying operational relationship.

Common questions

Q: Was the Georgia apartment-sale gain nonbusiness income?
A: No. The Department classified it as business income.

Q: How was the gain treated for Florida purposes?
A: It was subject to formulary apportionment rather than allocated entirely to Georgia.

Q: Why did Florida find a unitary business?
A: The financing and real-estate operations were linked by common control, recurring loans and guarantees, financial direction, management, and shared operational resources.

Q: Did moving the properties into a second-tier partnership before the sale separate the Georgia property?
A: No. The taxpayer still indirectly controlled the property, and the restructuring did not change the underlying flow of value.

Q: Were the loans treated as passive investments?
A: No. The Department viewed the recurring loans and guarantees as operational assets used to acquire and expand the group's real-estate operations.

Q: Can another corporate group rely on this TAA?
A: Not automatically. The advisement states that it binds the Department only under the facts and circumstances described in the request, and later legal changes or judicial interpretations may produce a different result.

Citations and references

• Fla. Stat. § 220.03(1)(r) — nonbusiness income and the unitary-business limitation
• Fla. Stat. § 220.13(2)(j) — Florida taxable-income adjustment described by the ruling
• I.R.C. § 1374 — federal built-in gain discussed in the facts
• ASARCO, Inc. v. Idaho State Tax Commission, 458 U.S. 307 (1982)
• Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992)
• Container Corp. of America v. Franchise Tax Board, 463 U.S. 159 (1983)
• Mobil Oil Corp. v. Commissioner of Taxes of Vermont, 445 U.S. 425 (1980)
• Brunner Enterprises, Inc. v. Department of Revenue, 452 So. 2d 550 (1984)
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 96C1-005

Original ruling text

Dec 03, 1996

Re: TAA 96(C)1-005
XXX ("Corporation A")
XXX ("Corporation B")
XXX ("Corporation C")
XXX ("Limited Partnership A")
XXX ("Limited Partnership B")
XXX ("Limited Partnership C")
Nonbusiness Income for Sale of Georgia Realty
s. 220.03(1)(r), F.S.

Dear :

This is in response to your letter of June 5, 1996, in which you
requested a Technical Assistance Advisement regarding the
treatment of the gain from the sale of Georgia real property as
business or nonbusiness income pursuant to Section 220.03(1)(r),
F.S.

FACTS

The taxpayer, Corporation A, is a Georgia corporation which has
elected to be taxed for federal income tax purposes as an S
corporation. It is engaged in commercial lending and financing
including the making of loans to several affiliated real estate
partnerships. Corporation A is successor by merger to
Corporation B, also a Georgia corporation but a Subchapter C
corporation. It is also engaged in commercial lending and
financing including the making of loans to its real estate
operations held in the form of partnerships or subsidiary
corporations. It is also engaged in property management,
ownership, and operation. From time to time, the above
referenced corporations would also guarantee loans made by
third-party financial institutions to their limited partnerships
or subsidiaries for purposes of constructing or improving
apartment complexes and other realty.

The apartment complexes at issue in this advisement are two

residential apartment complexes in the Tampa/Clearwater area,
and a single apartment complex in Cobb County, Georgia. These
apartment complexes, amongst others, were owned and operated by
a wholly owned subsidiary of Corporation B (Corporation C)
through two partnerships. Limited Partnership A, was a 100%
owned limited partnership which held the two residential
complexes in the Tampa/Clearwater area, and Limited Partnership
B, was a 100% owned limited partnership which held the apartment
complex in Cobb County, Georgia until July 1, 1994.

As of July 1, 1994, all of Corporation B's real estate holdings,
held through partnership interests or subsidiary corporations,
were sold with the exception of the two Tampa/Clearwater
apartment complexes and the Cobb County, Georgia complex. On
July 1, 1994, the corporate stock of Corporation C was
liquidated with Limited Partnership A and Limited Partnership B,
the limited partnerships which own the apartment complex
property in Tampa/Clearwater and Cobb County, Georgia,
contributed to a second-tier limited partnership (Limited
Partnership C). Also on this same date (July 1, 1994),
Corporation B was merged into Corporation A, an S corporation.

Due to the provisions in Section 1374, Internal Revenue Code,
the capital gain realized of $690,000 is subject to federal
corporate tax on the amount in excess of $25,000. The Florida
Statutes in Section 220.13(2)(j), F.S., include the amount of
this excess as the taxable income. Accordingly, the
apportionment of the capital gain as business income between
Florida and Georgia, or its allocation as nonbusiness income
entirely to the State of Georgia is an issue for the taxpayer.

Corporation B and its affiliated group filed federal and Florida
consolidated returns for all tax years prior to the date of the
merger, July 1, 1994. Corporation B, a Georgia corporation
based in Atlanta, Georgia, incurred Florida corporate nexus
through its limited partnership interests which held Florida
realty. Corporation C was included in the federal and Florida
consolidated returns through June 30, 1994. Corporation A did
not file Florida corporate returns before July, 1994, as it was
not subject to Florida corporate income tax prior to such date,
not having any connection with the State of Florida.

QUESTION

Whether the capital gain realized by Corporation A, through its
limited partnership interest, from the sale of the Georgia
apartment complex constitutes nonbusiness income for Florida
income tax purposes?

DISCUSSION AND ANALYSIS OF LAW

Paragraph 220.03(1)(r), F.S., defines nonbusiness income and
states:

"Nonbusiness income" means rents and royalties from real or
tangible personal property, capital gains, interest,
dividends, and patent and copyright royalties, to the
extent that they do not arise from transactions and
activities in the regular course of the taxpayer's trade or
business. The term "nonbusiness income" does not include
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, or any amounts which could be
included in apportionable income without violating the due
process clause of the United States Constitution....
(emphasis supplied)

The applicable judicial test is whether this income in question
arose out of a unitary business, or had some operational
connection with the State of Florida. There would exist this
connection with Florida if this income was derived from
taxpayer's unitary business some part of which was conducted in
Florida. See ASARCO, Inc. v. Idaho State Tax Commission, 458
U.S. 307 (1982); Brunner Enterprises, Inc. v. Department of
Revenue, 452 So.2d 550 (1984) ("Thus, we hold that out-of-state
investment income earned by a foreign corporation doing business
in Florida is only taxable under the Florida Corporate Income
Tax Code if the Florida enterprise is part of a unitary
business.").

Recently, the United States Supreme Court, in Allied-Signal Inc.

v. Director, Division of Taxation, 504 U.S. 768, 112 S.Ct. 2251,
119 L.Ed.2d 533 (1992), refused to overrule ASARCO and held that
a state may constitutionally include an increment of income
received from a nondomiciliary corporation in apportionable
income if the increment of income is derived from either an
enterprise unitary with the taxpayer or from a transaction that
serves an operational function rather than an investment
function.

In Allied-Signal, supra, the three "hallmarks of a unitary
business", which are also known as the factors of profitability,
were discussed in determining a unitary business; these factors
represent contributions to income arising from "functional
integration, centralization of management, and economies of
scale." In applying "factors of profitability" to the facts of
any case, it is essential that the out-of-state activity is "...
related in some concrete way to instate activities. The
functional meaning of this requirement is there be some sharing
or exchange of value not capable of precise identification or
measurement... beyond the mere flow of funds arising out of a
passive investment or a distinct business operation... which
renders the formula apportionment a reasonable method of
taxation." See Container Corporation of America v. Franchise
Tax Board, 463 U.S. 159 (1983).

Applying the facts of this case, the taxpayer argues that it has
continued to hold the real estate investments of Limited
Partnership A and Limited Partnership B as nonbusiness real
estate. Therefore, the gain from the sale of the Cobb County,
Georgia complex is a "transaction not arising in the regular
course of the taxpayer's trade or business," such regular trade
or business consisting of the commercial finance business. The
taxpayer further supports its nonbusiness position apparently
arguing that the commercial finance business of Corporation B
which is now Corporation A is separate and distinct from the
operations of Corporation C and now Limited Partnership C, which
is the management, ownership and operation of various apartment
complexes. As previously explained, the nonbusiness standard in
the Florida definition is grounded upon the apportionability of
income under the Due Process Clause of the U.S. Constitution,
and that income is apportionable if derived from the flow of

value generated by a unitary business conducted in part within
the State of Florida. The taxpayer's argument that the
management and operation of apartment complexes is separate and
distinct, and thus discrete business from its commercial finance
business, is a nonunitary distinction which the Florida
Department of Revenue addresses in this advisement.

The U.S. Supreme Court decisions since 1978 have held that, as a
constitutional matter, a State can require the inclusion of an
item of income in the taxpayer's preapportionment tax base
(adjusted federal income), provided that such income derives
from activities not merely owned, but actually controlled by the
taxpayer, and such activities are unitary with the taxpayer's
other activities being conducted in the taxing State. In
determining whether various activities or transactions are part
of a unitary business, or are discrete and not interrelated, the
central management, functional integration, and economies of
scale contributions of the entire group of corporations
controlled by the taxpayer or the taxpayer's parent must be
taken into account. As stated in Container Corporation of
America v. Franchise Tax Board, supra, at 166, the prerequisite
to a finding of a unitary business is "that there be some bond
of ownership or control uniting the purported `unitary
business'." The U.S. Supreme Court has noted that the form of
investment or the nature of the income does not limit the
contours of an otherwise controlled business enterprise. For
example, the fact that the income at issue is received in the
form of dividends from a corporate subsidiary rather than the
net earnings of a division does not require a break in the scope
of the unitary analysis so that the holding of corporate stock
and the dividends received therefrom constitute a discrete or
separate taxable event. The U.S. Supreme Court in Mobil Oil Co.
v. Commissioner of Taxes of Vermont, 445 U.S. 425, 100 S.Ct.
1223, 63 L.Ed.2d 510 (1980), stated the following in this
regard:

It remains to be considered whether the form in which the
income was received serves to drive a wedge between Mobil's
foreign enterprise and its activities in Vermont. In
support of the contention that dividend income ought to be
excluded from apportionment, Mobil has attempted to

characterize its ownership and management of subsidiaries
and affiliates as a business distinct from its sale of
petroleum products in this country. Various amici also have
suggested that the division between parent and subsidiary
should be treated as a break in the scope of unitary
business, and that the receipt of dividends is a discrete
"taxable event" bearing no relation to Vermont.

At the outset, we reject the suggestion that anything is to
be gained by characterizing receipt of the dividends as a
separate "taxable event." In Wisconsin v. J.C. Penney Co.,
supra, the Court observed that "tags" of this kind "are not
instruments of adjudication but statements of result," and
that they add little to analysis. 311 U.S., at 444.

Nor do we find particularly persuasive Mobil's attempt to
identify a separate business in its holding company
function. So long as dividends from subsidiaries and
affiliates reflect profits derived from a functionally
integrated enterprise, those dividends are income to the
parent earned in a unitary business. Superficially,
intercorporate division might appear to be a more
attractive basis for limiting apportionability. But the
form of business organization may have nothing to do with
the underlying unity or diversity of business enterprise.
Had appellant chosen to operate its foreign subsidiaries as
separate divisions of a legally as well as a functionally
integrated enterprise, there is little doubt that the
income derived from those divisions would meet due process
requirements for apportionability. Cf. General Motors
Corp. v. Washington, 377 U.S. 436, 441 (1964).
Transforming the same income into dividends from legally
separate entities works no change in the underlying
economic realities of a unitary business, and accordingly
it ought not to affect the apportionability of income the
parent receives. (emphasis supplied)

It is clear from your request dated June 5, 1996, that the
Florida and Georgia apartment complexes were managed and
operated, at least on a daily basis, by Corporation C, a wholly
owned subsidiary of Corporation B. From information contained

in several telephone conversations, it was determined that PMC
also owned, managed and operated a number of other apartment
complexes. From these same conversations, it was learned that
the financing for all of the apartment complexes owned by
Corporation C was obtained by loans from Corporation B or loan
guarantees made by Corporation B. The real estate loans made by
Corporation B, and subsequent to the merger by Corporation A,
were substantially made to finance real estate holdings of
subsidiaries and limited partnerships in which they had a
controlling investment interest.

In reviewing the underlying activities of both Corporation C and
Corporation B, there is the controlling ownership and
substantial financing provided by or through Corporation B which
demonstrates the contribution and dependency necessary for
finding substantial interdependency. The fact that the apartment
complexes were subsequently owned by a second-tier partnership
indirectly controlled by Corporation A shortly prior to the sale
of the apartment complexes does not alter the flow of value
derived from the taxpayer's (Corporation A's) affiliated group
which enhanced the value of the real estate complexes. Neither
does the recontribution change the fact that the apartment
complexes were still controlled at the time of their sale by
Corporation A.

Just as the exploration, drilling, and refining of petroleum by
the foreign subsidiaries of Mobil Oil provided vertical
integration and mutual interdependency for Mobil Oil's marketing
activities in Vermont, the real estate financing (including loan
guarantees) by Corporation B and Corporation A provides the
interdependency and interrelationship for Corporation C's and
various limited partnerships' real estate interests, including
the apartment complexes at issue in this advisement. The U.S.
Supreme Court refused to treat the operations of Mobil's foreign
subsidiaries as discrete businesses simply because they were
held in a separate corporate form, but rather looked at the
underlying interrelationship and interconnections of the
subsidiaries' foreign activities with those of Mobil Oil in
Vermont and the other U.S. States. We apply the same unitary
standard in this case and determine there is a substantial
unitary connection between both the real estate management and

the real estate/commercial financing operations.

In reviewing the structure and operations of Corporation A and
its affiliated group, it appears that Corporation B's management
role was greater than the mere oversight of capital structure,
and major debt (i.e., stewardship activity); rather the nature
of the management is more of providing direction to the
subsidiary and partnership operations especially with respect to
financial decisions and capital acquisitions. Clearly with
respect to the refinancing of the apartment complex property in
Florida which required the separation of the Cobb County
property into a separate partnership, this is the type of
financial transaction that Corporation B's managers would be
involved in with respect to the real estate operations. As
stated in Container Corp., supra, in distinguishing F.W.
Woolworth, the Container Court stated in footnote 19:

The difference lies in whether the management role that the
parent does play is grounded in its own operational
expertise and its overall operational strategy. In this
case, the business "guidelines" established by appellant
for its subsidiaries, the "consensus" process by which
appellant's management was involved in the subsidiaries'
business decisions, and the sometimes uncompensated
technical assistance provided by appellant, all point to
precisely the sort of operational role we found lacking in
F.W. Woolworth. (emphasis supplied)

It should also be noted that the purpose of the loans and loan
guarantees by Corporation B, and subsequently by Corporation A,
when viewed in light of their recurring nature throughout the
taxpayer's real estate operations, results in the loans and loan
guarantees being characterized as operational assets rather than
investment assets. The distinction in these types of activities
was made in Container and again in Allied-Signal, Inc. v.
Director of Taxation, supra. As stated in Container, supra,
footnote 19:

Two of the factors relied on by the state court deserve
particular mention. The first of these is the flow of
capital resources from appellant to its subsidiaries

through loans and loan guarantees. There is no indication
that any of these capital transactions were conducted at
arm's-length, and the resulting flow of value is obvious.
As we made clear in another context in Corn Product's Co.
v. Commissioner, 350 U.S. 46, 50-53 (1955), capital
transactions can serve either an investment function or an
operational function. In this case, appellant's loans and
loan guarantees were clearly part of an effort to insure
that "[t]he overseas operations of [appellant] continue to
grow and become a more substantial part of the company's
strength and profitability." Container Corporation of
America, 1964 Annual Report 6, reproduced in Exhibit I to
Stipulation of Facts. See generally id., at 6-9, 11.
(emphasis supplied)

It seems clear that the loans and loan guarantees made by and
through Corporation B and Corporation A were not for investment
purposes to obtain a market rate of return on idle funds, but
rather were for purposes of seeking to acquire and expand the
taxpayer's real estate operations both within and without
Florida. The managerial and financial operations with regard to
the apartment complexes and other real estate provide a
contribution/dependency relationship between Corporation B, and
subsequently Corporation A, and the taxpayer's subsidiary and
limited partnership interests. The financial activities are not
discrete and independent of the real estate operations. The real
estate provides collateral for loans and a source of income to
make loan payments, while the commercial loan experience and
real estate management expertise provides managerial assets
necessary for acquiring, financing, and operating the real
estate investments.

This type of relationship is discussed in the California Supreme
Court case Edison California Stores, Inc. v. McColgan, 30 Cal.2d
472, 183 P.2d 16 (1947), wherein the court states:

if the operation of the portion of the business done within
the State is dependent upon or contributes to the operation
of the business without the State, the operations are
unitary.

Additionally, the U.S Supreme Court in F.W. Woolworth, supra,
held:

In this case the parent company's operations are not
interrelated with those of its subsidiaries so that one's
"stable" operation is important to the other's "full
utilization" of capacity. Exxon v. Wisconsin Dept. of
Revenue, 47 U.S. 207, at 218, 225 (1980).

In the instant circumstances, Corporation B's, and subsequently
Corporation A's, managerial and financial services are
interrelated with the real estate operations so that the "stable
operation" of the taxpayer was important to Corporation C's
"full utilization" of capacity.

RESPONSE

The managerial and financial operations of Corporation B, and
subsequently Corporation A, are too closely related to
Corporation C and the taxpayer's limited partnerships to
conclude that the real estate operations are nonunitary with the
taxpayer's financial and loan operation. The stable operation
of the financial enterprise is important to the full utilization
of the resources of the real estate complexes and other real
estate operations, and vice-versa. The apartment complexes
managed by Corporation C required to too great an extent the
common use of various resources, services, and employees for
day-to-day operations to justify the segregation of the Cobb
County apartment operation from that of the Florida complexes or
others. Accordingly, the treatment of the gain from the sale of
the Cobb County apartment complex constitutes business and not
nonbusiness income pursuant to Section 220.03(1)(r), F.S., and
is subject to formulary apportionment.

This response constitutes a Technical Assistance Advisement
under s. 213.22, F.S., which is binding on the Department only
under the facts and circumstances described in the request for
this advice as specified in s. 213.22, F.S. Our response is
based on those facts and the specific situation summarized
above. You are advised that subsequent statutory or
administrative rule changes or judicial interpretations of the

statutes or rules upon which this advice is based may subject
similar future transactions to a different treatment than
expressed in this response.

You are further advised that this response and your request are
public records under Chapter 119, F.S., which are subject to
disclosure to the public under the conditions of s. 213.22, F.S.
Your name, address, and any other details which might lead to
identification of the taxpayer must be deleted by the Department
before disclosure. In an effort to protect the confidentiality
of such information, we request you notify the undersigned in
writing within 15 days of any deletions you wish made to the
request or the response.

Sincerely,

Harry A. Baucom
Tax Law Specialist
Tax Policy and Dispute Resolution

HAB/hb
Control No: 25777
Enclosure