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