How did Florida treat a consolidated group's gains and sales-factor receipts from major stock and operating-asset dispositions?

Plain-English summary

The gains from the group's major stock and operating-asset sales were business income, but the sale prices were excluded from the Florida sales factor. The dispositions involved a subsidiary's stock, a linerboard mill, box plants, and related assets used in the taxpayer's unitary business.

The Department rejected the group's proposed split-year approach. The group could not calculate one Florida apportionment factor through the day before the sales and a second factor for the rest of the year, then apply each to the corresponding period's income.

Although the asset-sale receipts sharply changed the sales factor, the Department's comparison of the standard formula with the taxpayer's proposed method showed a difference of less than 10%. It treated that difference as within the substantial margin of error recognized for apportionment formulas, not a constitutional distortion requiring the proposed alternative method.

What this means for you

Classification of the gain and treatment of gross receipts in the sales factor were separate questions. Here the gains remained apportionable business income even though the extraordinary sale prices were removed from the sales-factor fraction.

Large one-time transactions do not automatically authorize special accounting or a split tax year. Alternative apportionment requires more than showing that the ordinary factor changes substantially.

Common questions

Q: Were the disposition gains business or nonbusiness income? Business income.

Q: Were the stock and asset sale prices included in the Florida sales factor? No. The Department excluded them.

Q: Could the group use separate pre-sale and post-sale apportionment factors? No.

Q: Why was the proposed alternative rejected? The Department found the less-than-10% difference between methods insufficient to show material or unconstitutional distortion.

Citations and references

• Fla. Stat. § 220.03(1)(r) — nonbusiness-income definition
• Fla. Stat. § 220.03(1)(z) — sales definition
• Fla. Stat. § 220.152 — alternative apportionment
• Fla. Stat. § 220.41 — corporate return requirements
• Container Corp. of America v. Franchise Tax Board, 463 U.S. 159 (1983) — formula differences within the substantial margin of error
• Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768 (1992) — apportionment of unitary-business income
• Fla. Stat. § 213.22 — Technical Assistance Advisements

Source

• Landing page: Florida Tax Law Library
• Advisement: TAA 97C1-007

Original ruling text

Nov 07, 1997

Re: TAA 97(C)1-007
XXX ("Parent Company")
XXX ("Sub. A")
XXX ("Sub. B")
XXX ("Sub. C")
Corporate Income Tax - Filing Requirements for Federal Tax Apportionment of Adjusted Federal Income; Nonbusiness Income, Sales Factor Apportionment, Separate Tax Years ss. 220.03(1)(r), 220.152, 220.41 & 220.03(1)(z), F.S.

Dear :

This is in response to your letter dated August 6, 1997, in which you requested a Technical Assistance Advisement ("TAA") regarding the classification of gains from sale of assets as business or nonbusiness income and the proper apportionment of such gains including their inclusion or exclusion in the sales factor apportionment fraction.

FACTS

Parent Company is a Florida corporation and is the common parent of an affiliated group of corporations which file consolidated federal and consolidated Florida corporation income tax returns. With the exception of the 1996 calendar year, almost all of the eleven (11) wholly-owned subsidiaries have nexus with the State of Florida. Several of the wholly-owned subsidiaries operate exclusively in Florida.

During the tax year 1996, Parent Company sold the common stock of Sub. A, and sold a significant portion of the assets of Sub. B and Sub. C. The common stock of Sub. A was sold on April 11, 1996, for a tax gain of $77,690,438 with a sale price of
$123,314,795. An election was filed under Internal Revenue Code Section 338(h)(10) to treat the stock sale as an asset sale for tax purposes. Sub. B sold a linerboard mill on May 30, 1996 for a tax gain of $100,875,342 with a sale price of $196,275,170.

Sub. C disposed of 16 box plants on May 30, 1996 for a tax gain of $78,054,417 with a sales price of $137,569,334. These business operations that were sold accounted for approximately 85 percent of Parent Company and affiliates' consolidated total revenues.

The sales proceeds from the assets sold constitute $457,159,299. If these proceeds were included in the sales factor, the total consolidated sales would increase from $331,047,041 to
$784,577,341. The numerator of the consolidated sales factor would increase from $168,191,698 to $500,500,312. This inclusion more than doubles the numerator and denominator of the consolidated sales factor. As to the effect on the sales factor of the individual corporations whose assets were sold, the Florida sales of one of the three entities increased by almost 15 times. The sales factor of Sub. B, before weighing, increased from 19.78% to 78.43%, and after weighing increased from 9.89% to 39.21%. Such increase would exclusively result from the inclusion of the sales proceeds from the asset sales.

QUESTIONS

1. Will the sale of assets of Parent Company (either stock
   or assets) be considered business or nonbusiness income for Florida purposes?
2. If considered business, can the sales price be excluded
   from the Florida sales factor due to its distorting effect?
3. Can the consolidated group calculate its Florida
   apportionment factor as of the day before the asset sales and apply it to the consolidated group income through the period of the sale? Then can the consolidated group calculate its Florida apportionment factor from the date of the asset sales to the end of the tax year and apply it to the consolidated group income for that period?

DISCUSSION AND ANALYSIS OF LAW

With respect to the first question, the taxpayer asks whether the sale of assets of Parent Company, either the stock or the assets, will be considered business or nonbusiness income for Florida purposes? Section 220.03(1)(r), F.S., defines

"Nonbusiness income" in the following manner:

(r) "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 emphasized language is part of a 1984 amendment passed by the Florida legislature to more narrowly define "nonbusiness income" for purposes of Chapter 220, Florida Statutes. With the passage of the amendment, only such amounts of income are considered nonbusiness income where to apportion such amounts under a formula mechanism would constitute a violation of the Due Process Clause of the United States Constitution. See Section 11, Chapter 84-549, Laws of Florida, effective for taxable years beginning on or after September 1, 1984. The 1984 amendment represents language added to the term "Nonbusiness income" immediately after and in response to the Florida Supreme Court decision in Brunner Enterprises, Inc. v. Department of Revenue, 452 So.2d 550 (Fla. 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.

The income at issue concerns gains derived from the sale of various box plants, a linerboard mill, and communication equipment all used in the taxpayer's unitary business. In a recent U.S. Supreme Court decision in Allied-Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 112 S.Ct. 2251, 119 L.Ed.2d 533 (1992), the entire Court agreed that the payee

and payor need not be engaged in the same unitary business as a prerequisite to apportionment in all cases. The U.S. Supreme Court in Allied-Signal stated:

What is required instead is that the capital transaction serve an operational rather than an investment function... To be sure, the existence of a unitary relation between the payor and the payee is one means of meeting the constitutional requirement. Thus, in ASARCO and Woolworth we focused on the question whether there was such a relation. We did not purport, however, to establish a general requirement that there be a unitary relation between the payor and the payee to justify apportionment, nor do we do so today. (emphasis supplied)

The Allied-Signal Court stated that the determination whether a transaction serves an operational or an investment function focuses on the objective of the characteristics of the asset's use and its relation to the taxpayer and its activities within the taxing state. The characteristics of the asset's use with respect to the assets sold was for the manufacture of various boxes used as containers and various forest products. Such assets such as the linerboard mill were used in and were an essential part of the Parent Company's and affiliates' unitary forest and lumbermill operation. The utilization of these assets to derive income from forestry operations including the manufacturing of containers provided an operational or functional relationship between the assets sold and the lumbermill operations. This determination is consistent with the Department's rules pertaining to nonbusiness income where in Rule 12C-1.016(1)(b)2., Ex. 1 & 2, F.A.C., it is held that gain or loss from the sale of real or tangible or intangible personal property constitutes business income if the property while owned by the taxpayer was used in the taxpayer's trade or business. Accordingly, it is concluded that the gains and losses from the asset and stock sales constitute business income and not nonbusiness income.

In regard to the second question, the Department views the asset and stock sales as nonrecurring types of disposition. The sales factor of the apportionment formula normally include "all gross

receipts" from sales of real and tangible personal property. See subsection 220.15(5), F.S. However, section 220.152, F.S., states that where the apportionment methods of section 220.15 (which includes subsection 220.15(5), F.S.) and 220.151, F.S., do not fairly represent the extent of a taxpayer's tax base attributable to this state, the taxpayer may petition for, or the department may require, in respect to all or any part of the taxpayer's tax base, if reasonable: (1) separate accounting; (2) the exclusion of any one or more factors; (3) the inclusion of one or more additional factors which will fairly represent the taxpayer's tax base attributable to this state; or (4) the employment of any other method which will produce an equitable apportionment. The Florida Department of Revenue has always viewed the recognition of substantial gross receipts from an incidental or occasional sale of a fixed asset used in the regular course of the taxpayer's trade or business as materially distorting the sales factor. See also Rule 12C-1.0155(1)(b), F.A.C.

The sales factor of the apportionment formula is intended to reflect the extent or degree that the taxpayer derives its income from its marketing activity in one state jurisdiction compared to all U.S. states. This might be marketing activity related to the sale of goods or services, but it is intended to reflect the relationship that such marketing efforts, geared towards the sale of the taxpayer's "regular" product, conducted in Florida, have compared to the same efforts conducted throughout the United States. As stated by Professor Walter Hellerstein:

The term "sales factor" may have been adopted because the three factor formula had its origin in, and was designed for, mercantile and manufacturing companies. The gross receipts factor or sales factor, as it had developed with the general use of the sales destination test, is designed to give weight in the apportionment to the States in which the taxpayer markets its goods.

(State Taxation I: Corporate Income and Franchise Taxes, at 8.6[2], (1983))

The result of including the sale proceeds from the stock sale and asset sales in the sales factor of the apportionment formula is to triple the sales factor numerator and to more than double the sales factor denominator. See "Facts" as previously stated. When this is added to the fact that such asset sales represent a completely different Florida percentage from the percentage generated exclusively by the trade sales, in our opinion it results in a clearly distortive factor. The sale of business assets in Florida is 73% of the sales of business assets everywhere. The Florida trade sales without the sale of business assets is approximately 20.5% of the trade sales everywhere. In any sense of the word, the gross receipts from the occasional sales at issue represent a substantial amount of the total gross receipts. Also, to include the receipts from the stock and asset sales in the sales factor, clearly creates a distortive result in that the sales factor does not represent the relationship of the taxpayer's Florida marketing activities to the taxpayer's total marketing efforts. For these reasons, we agree with the taxpayer that pursuant to section 220.152, F.S., the gross receipts from the stock sale and asset sales are to be excluded from the sales factor of the apportionment formula.

With respect to the third question, the taxpayer requests the Department divide the tax year into two parts. The first part of the year would include the period from January 1, 1996 through May 31, 1996, and the second part of the year would include the period from June 1, 1996 through December 31, 1996. Based on the information provided by the taxpayer, the apportionment factor for the first five months (through May 31, 1996) would constitute an apportionment factor of 52.6651%, and the apportionment factor for the last seven months (through December 31, 1997) would constitute a factor of 98.9832%. The apportionment factor for the entire twelve month period, without the inclusion of the gross receipts from the sale of stock and assets included in the sales factor, would constitute a factor of 61.4294%.

The consolidated taxable income is derived from the federal computation of such income pursuant to sections 1502 and 63 of the Internal Revenue Code. See subsection 220.131(4), F.S. The

federal taxable income is the starting point for determining the apportionable tax base (adjusted federal income). In making all of the federal determinations affecting federal taxable income, they are made based upon the entire tax accounting period (i.e., the full 12 month period in this case). For example, in determining whether there is a consolidated net operating loss, that determination is based upon the operations for the full 12 month period.

Additionally, in determining the utilization of a net operating loss into a consolidated return tax year, the net operating loss is applied against the pre-loss consolidated taxable income for the entire tax year. Consistent with the computation of taxable income utilizing federal tax concepts, subsection 220.41(1), F.S., states in part that "the taxable year of a taxpayer shall be the same as the taxable year of such taxpayer for federal income tax purposes." Paragraph 220.03(1)(z), F.S., states that "`Taxable year' means the calendar or fiscal year upon the basis of which net income is computed under this code, including, in the case of a return made for a fractional part of the year, the period for which such return is made." (emphasis supplied) Accordingly, to separate the tax year that is a 12 month period for federal tax purposes into a five month and seven month periods would, at least for computing the apportionable tax base (adjusted federal income), produce a determination substantially different from the tax base (taxable income) computed for federal tax purposes utilizing federal concepts. This would be clearly contrary to our Florida Statutes described above.

On page four of your request for a TAA, you make the argument that to avoid distortion of the Florida apportionment factor the provisions of section 220.152, F.S., and Rule 12C-1.0152(1)(a), F.A.C., should be applied to accomplish the separate apportionment factor and apportioned income described above. Your equitable calculation would consist of calculating a Florida apportionment factor as of the period before the asset sales and apply it to the consolidated group income through the period of the sale, and another consolidated apportionment factor for the period after the asset sale through the end of the tax year. The problem with this suggestion is that, unlike the material distortion shown in question 2, the taxpayer does

not show and probably cannot show a material distortion with regard to the apportionment of income utilizing a full federal tax year. As stated above, the apportionment factor utilizing a five month tax year (from January 1 to May 31) is a factor of 52.6651% while the apportionment factor using a twelve month period is 61.4294%. This is a difference of less than 10%. I understand that approximately 85% of the income is earned during this five month period, but still some of the advantage from a lower factor would assuredly be offset by a 98% factor for the last seven months of 15% of the apportionable income. In any case, a 10% difference in apportionment factor does not represent a distortion of U.S. Constitutional dimension.

In 1980, the Florida Supreme Court addressed the application of section 220.152, F.S. (formerly section 214.73, F.S.), and in Roger Dean Enterprises, Inc. v. Florida Department of Revenue, 387 So.2d 358 (Fla. 1980), held in part:

The relief provision quoted above tracks the language appearing in section 18 of the Uniform Division of Income for Tax Purposes Act (UDITPA). The Act deals with the allocation and apportionment of income of multistate businesses for tax purposes. There is a very strong presumption in favor of normal three-factor apportionment and against the applicability of the relief provisions. See Donald M. Drake Co. v. Department of Revenue, 263 Or. 26, 500 P.2d 1041 (1972). The relief provision should be used where the statute reaches arbitrary or unreasonable results so that its application could be attacked successfully on constitutional grounds. Departures from the basic formula should be avoided except where reasonableness requires. Deseret Pharmaceutical Co., Inc. v. State Tax Commissioner, 579 P.2d 1322 (Utah 1978); see Pierce, The Uniform Division of Income for State Tax Purposes, 35 Taxes 747, 782 (1957). The relief provisions applicable to apportionment should not be used to remove an out-of-state stock sale made by a foreign-chartered corporation subject to its income tax from the tax base. See F. W. Woolworth v. Commissioner of Taxes, 133 Vt. 93, 328 A.2d 402 (1974); Hoosier Engineering Co. v. Shea, 124 Vt. 341, 205 A.2d 821 (1964).

The Roger Dean Court clearly stated that the alternative apportionment provisions of section 220.152, F.S. (formerly section 214.73, F.S.), is to be applied where the normal threefactor apportionment statute reaches arbitrary or unreasonable results so that its application can be successfully attacked on constitutional grounds. The U.S. Supreme Court has identified benchmarks limiting the states' authority to adopt formulas for apportionment of income, where a formula distorts the amount of income attributed to the taxing state. In Norfolk and Western Railway Co. v. Missouri State Tax Commission, 390 U.S. 217, 88 S.Ct. 995, 19 L.Ed.2d 1201 (1968), the U.S. Supreme Court determined that distortion percentages of 162.1% and 205.62% were unconstitutional. In Hans Rees' Sons, Inc. v. North Carolina ex rel. Maxwell, 283 U.S. 123, 51 S.Ct. 385, 75 L.Ed. 879 (1931), the U.S. Supreme Court found distortion in excess of 250% to be impermissible.

Obviously, the difference in this case, which is less than 10% between the standard three-factor apportionment method and the taxpayer's proposed alternative apportionment method, does not come close to the distortion percentages in the Norfolk and Western Railway Co. and Hans Rees' Sons decisions. In a more recent decision of the U.S. Supreme Court in Container Corporation of America v. Franchise Tax Board, 463 U.S. 159, 103 S.Ct. 2933, 77 L.Ed. 545 (1983), the Container Court stated in part:

The problem with all this evidence, however, is that it does not by itself come close to impeaching the basic rationale behind the three-factor formula... Indeed, it would be difficult to come to such a conclusion on the basis of the figures in this case: for all of appellant's statistics showing allegedly enormous distortions caused by the three-factor formula, the tables we set out at nn.1112, supra, reveal that the percentage increase in taxable income attributable to California between the methodology employed by appellant and the methodology employed by appellee comes to approximately 14%, a far cry from the more than 250% difference which led us to strike down the state tax in Hans Rees' Sons, Inc., and a figure certainly

within the substantial margin of error inherent in any method of attributing income among the components of a unitary business. (emphasis supplied)

Again, the 10% difference in this issue is less than the 14% difference which existed in Container Corp., where the U.S. Supreme Court held such percentage difference does not come close to impeaching the basic rationale behind the three-factor formula and is certainly a figure within the "substantial margin of error" inherent in any apportionment method attributing unitary business income. A 10% difference would likewise be a figure within the "substantial margin of error," and the threefactor apportionment for such a difference would likewise be constitutionally upheld.

In separating the tax year into two parts, the taxpayer is using some type of special accounting or allocation method. Whether the method of accounting used is to separate net income based on functions, geography or territory, nature of the transaction, or the timing of the recognition of income and deductions (or subtractions), "a company's internal accounting techniques are not binding on a State for tax purposes." Exxon Corp. v. Wisconsin Dept. of Revenue, supra. "Accounting practices for income statement may vary considerably according to the problem at hand... A particular accounting system, though useful or necessary as a business aid, may not fit the different requirements when a State seeks to tax values created by business within its borders." Butler Bros. v. McColgan, 315 U.S. 501, at 507-508 (1942).

The difference of 10% between the methods of apportionment may be due to the fact that substantial activities are related to a single transaction or an entire business operation which begins out-of-state in the beginning of the year and is completed in Florida at the end of the year. Additionally, there may be activities resulting from property, payroll, or sales not properly accounted for by the taxpayer's internal accounting method. Further, the accounting method may capitalize expenditures or defer the reporting of items, which affects the earning of unitary income, but such activities are not adequately measured or the subtle transfers of value are not

accounted for. Clearly in these types of situations, as well as others, the accounting method presented by the taxpayer would not present an accurate picture of Florida apportioned income.

The U.S. Supreme Court has recently stated, in regard to a unitary business in Allied-Signal, Inc. v. Director, Division of Taxation, supra, the following:

Rather than isolating the intrastate income-producing activities from the rest of the business, a state may tax a corporation on an apportioned sum of the corporation's multi-state business if the business is unitary. E.g. ASARCO, Inc. v. Idaho State Tax Commission, 458 U.S. 307, at 317 (1982). (emphasis supplied)

Since the taxpayer's business is a unitary business, it is appropriate for its unitary income to be taxed based on a fairly construed apportionment formula. There may be activities not represented in the formula but this does not, in itself, require the use of another accounting method. Where a business is unitary, there often are activities not properly or adequately measured by internal accounting methods. What is important is that the apportionment method is fair and captures a substantial portion of the taxpayer's unitary operations. The exclusion of the receipts from the sale of stock and assets in question 2 is an effort by the Department to include additional fairness in the apportionment method. The 10% differential may or may not reflect a failure in the three-factor formula, but in any case such measure does not represent a material distortion for constitutional purposes and section 220.152, F.S.

RESPONSES

1. The sale of assets of Parent Company (either stock or
   assets) will be considered business income.
2. The sale price of stock and assets is to be excluded
   from the Florida sales factor.
3. The consolidated group cannot calculate its Florida
   apportionment factor before the asset sales and apply it to the consolidated group income through the period of the sale. Additionally, the consolidated group cannot calculate

its Florida apportionment factor from the date of the asset sales to the end of the tax year and apply it to the consolidated group income for that period.

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
Technical Assistance and
Dispute
Resolution

HAB/hb
Control No: 30495