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