CHAMPION INT'L CORP. V. BUREAU OF REVENUE, 1975-NMCA-106, 88 N.M. 411, 540 P.2d
1300 (Ct. App. 1975)
CHAMPION INTERNATIONAL CORPORATION,
Appellant,
vs.
BUREAU OF REVENUE, State of New Mexico, Appellee.
COURT OF APPEALS OF NEW MEXICO
1975-NMCA-106, 88 N.M. 411, 540 P.2d 1300
Motion for Rehearing Denied August 13,
1975; Petition for Writ of Certiorari Denied October 6, 1975
Benjamin J. Phillips, White, Koch, Kelly
& McCarthy, Santa Fe, Dennis J. Barron, David A. Beanblossom, Frost &
Jacobs, Cincinnati, Ohio, for appellant.
Toney Anaya, Atty. Gen., Jan E. Unna,
Bureau of Revenue, Asst. Atty. Gen., Santa Fe, for appellee.
SUTIN, J., wrote the opinion. WOOD, C.J.,
and LOPEZ, J., specially concur.
{1} Champion International
Corporation (Champion) appeals the Decision and Order of the Commissioner of
Revenue (Commissioner) which assessed additional corporate income tax for the
year 1972.
{2} The Commissioner found
that Champion erroneously allocated as
"nonbusiness income"
the income it received in the form of interest, rent, and gains from the sale
of assets. The Commissioner found that such income was properly classified as
business
income" under § 72-15A-17(A), N.M.S.A. 1953 (Repl. Vol. 10, pt. 2, 1973
Supp.). This section falls within the Uniform Division of Income for Tax
Purposes Act, "UDITPA", [§§ 72-15A-16 to 72-15A-36], which provides
the uniform division for income tax purposes, among the states participating in
the Multistate Tax Compact, of the income of a multistate business. See §
72-15A-37.
{3} Champion is a New York
corporation engaged, in fifty states, in manufacturing and selling a variety of
wood products, including building materials, paper, pulp, packaging, and home
furnishings.
{4} Champion protested the
assessment made. At the hearing on Champion's protest of the assessment,
Champion was represented solely by an employee, a tax consultant. He had not
prepared the tax returns.
{*413} He evidenced
no knowledge of the conglomerate business operation of Champion. However,
Champion relied solely on this tax consultant at the hearing. Champion tendered
no business records, documents or other exhibits to support its claims.
{5} This case can be decided
by affirmance in two ways: (A) The record leaves us no basis on which to make
any determination whether all of Champion's activities were an integral part of
their New Mexico operations and (B) an analysis of the statute and its
application to Champion's income.
(A) No Basis to Make Determination
{6} A multistate business is
a "unitary business" for income tax purposes when operations
conducted in one state benefit and are in turn benefited by operations in
another state.
Great Lakes Pipe Line Co. v. Commissioner of Taxation,
272 Minn. 403, 138 N.W.2d 612 (1965). "If its various parts are
interdependent and of mutual benefit so as to form one integral business rather
than several business entities, it is unitary."
Webb Resources, Inc. v.
McCoy, 194 Kan. 758, 766, 401 P.2d 879, 886 (1965).
{7} On the other hand,
"... [I]f a multistate business enterprise is conducted in a way that one,
some or all of the business operations outside [New Mexico] are independent of
and do not contribute to the business operations within this State, the factors
attributable to the outside activity may be excluded."
Commonwealth v.
ACF Industries, Incorporated, 441 Pa. 129, 271 A.2d 273, 280 (1970). See,
Rudolph, State Taxation of Interstate Business: The Unitary Business Concept
and Affiliated Corporate Groups, 25 Tax L. Rev. 171 (1970).
{8} "Any assessment of
taxes made by the bureau is presumed to be correct." Section 72-13-32(C),
N.M.S.A. 1953 (Repl. Vol. 10, pt. 2, 1973 Supp.). The duty rests on Champion to
present "... evidence tending to dispute the factual correctness of the
assessments."
McConnell v. State ex rel. Bureau of Revenue, 83 N.M.
386, 387-88,
492 P.2d 1003, 1004-05 (Ct. App.1971). Champion had the burden to
overcome this presumption.
Mears v. Bureau of Revenue, 87 N.M. 240,
531
P.2d 1213 (Ct. App.1975).
{9} Champion has failed to
produce evidence that its business activity outside of New Mexico was dependent
or independent of its instate operations. Champion failed to show that
interest, rent, and gains income was not an integral part of its business
carried on in New Mexico. On the facts before us, no question is raised whether
any of its income is nonbusiness income because there is no evidence that its
activities were not part of a unitary business.
{10} The state of the record
leaves us no basis on which to make any determination as to whether all the
business activity of Champion was an integral part of their New Mexico
operations.
{11} By this conclusion, the
assessed additional corporate income tax for the year 1972 is affirmed.
(B) An Analysis of the Statute and its Application to
Champion's Income
{12} Champion contends that:
(1) Its income from interest, rents and the sale of logs
constituted "nonbusiness income" which could not lawfully be taxed by
the State of New Mexico.
(2) The amount that was attributable to the cutting of its
timber, and that was taxed by the federal government as IRC § 631(a) gain, was
unrealized income that could not lawfully be taxed by the State of New Mexico.
{13} These questions are
matters of first impression in New Mexico.
(1) Income from interest, rents and log sales constituted
"business income".
{14} Section 72-15A-17
defines "business income" and "nonbusiness income", under
UDITPA, as follows:
A. "Business income" means income arising from transactions
and activity in {*414} the regular
course of the taxpayer's trade or business and includes 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; [Emphasis added]
D. "Nonbusiness income" means all income other than
business income;....
{15} What is meant by the
italicized phrase, "transactions and activity in the regular course of the
taxpayer's trade or business"? This is broad terminology.
{16} We have been unable to
find a technical definition of the phrase. "Transaction" is defined
as "... something that is transacted: as a: a business deal...."
"Activity" is defined as "... an organizational unit for
performing a specific function;
also its duties or function...."
"Regular" is defined as "... steady or uniform in course,
practice, or occurrence... steadily pursued.... Synonyms: NORMAL, TYPICAL,
NATURAL...." "Course" is defined as "... accustomed
procedure: customary action: usual method of proceeding... policy chosen:
manner of conducting oneself... way of acting...." Webster's Third New
International Dictionary (Unabridged, 1961), at 2426, 22, 1913, 522.
{17} Accordingly, we define
the phrase "transactions and activity in the regular course of the
taxpayer's trade or business" in § 72-15A-17(A) as:
Business deals and the performance of a specific function in
the normal, typical, customary or accustomed policy or procedure of the
taxpayer's trade or business.
Cf. Western Natural Gas Company v. McDonald, 202 Kan.
98, 446 P.2d 781 (1968).
{18} The tax consultant for Champion
testified that interest income was derived from capital earned in the business.
Rather than have a large cash balance in the bank, Champion purchased
short-term investments and highly liquid assets from which interest income was
derived. This was a specific function of Champion. The money from these
short-term investments was needed for future business activity. It was usual
and customary in Champion's business to follow this practice, whenever there
was enough money or business income that was not immediately needed in the
business.
{19} Champion contends that
the determining factor is the nature of the transaction from which the interest
income was derived, and its relationship to Champion's business. The interest
income was derived from investments. Champion argues that this is not
"business income" because Champion is not in the investment business.
{20} We disagree. Champion's
representative testified that a normal and customary practice by Champion was
to invest excess capital, not needed for business purposes, in short-term
securities. Following our definition, supra, this was a specific function done
in the regular course of Champion's business. Therefore, Champion's investment
income is "business income".
{21} Champion's reliance on
Western
Natural Gas Company, supra, is misplaced. It deals, not with recurring,
customary investments, but with a one-time liquidation sale of all of the
taxpayer's oil and gas leases.
{22} Sperry and Hutchinson
Co. v. Department of Revenue, 527 P.2d 729 (Ore.1974) interprets the reach of a
statute almost identical to § 72-15A-17(A). Oregon is a party to the Multistate
Tax Compact. The court distinguished, (1) income from short-term investments
held to satisfy the corporation's need for capital from (2) long-term
investment income that is
used for other purposes. The former, the court
held, arises from the transactions and activity in the regular course of the
taxpayer's trade or business, and, therefore is
{*415}
business income. Champion has failed to distinguish their investments from
those found by the Oregon court to be business income.
{23} In the instant case,
Champion introduced no evidence as to the
use to which it put its
short-term investment income. This income was needed for future business
activity. It necessarily follows that the income was
used for this
purpose.
Great Lakes Pipe Line Co. v. Commissioner of Taxation, supra.
In the light of
Sperry and
Great Lakes, that the
use to
which it put this income determines whether it is "business income",
we affirm the Commissioner as to Champion's short-term investment income.
{24} Champion rented out
approximately five percent of its total office space. It claims that the income
derived from rent is not "business income" because Champion was not
in the business of renting real estate.
{25} Like
"interest" income, supra, the most reasonable inference to be drawn
from the record is that rental of available office space was a customary
procedure, done in the regular course of Champion's business. We find no
evidence in the record which contradicts this inference. Rental income was,
therefore, "business income".
{26} There was offered in
evidence, without objection, I.T. Regulation 17(b). Subsection (1) is entitled
Rents
from real and tangible personal property, and reads:
Rental income from real and tangible property is business
income if the property with respect to which the rental income was received is
used in the taxpayer's trade or business or is incidental thereto and therefore
is includable in the property factor under I.T. Regulation 26.
{27} Example iii under I.T.
Regulation 17(b)(1) reads as follows:
The taxpayer operates a multistate chain of men's clothing
stores. The taxpayer purchases a five-story office building for use in
connection with its trade or business. It uses the street floor as one of its
retail stores and the second and third floors for its general corporate
headquarters. The remaining two floors are leased to others. The rental of the
two floors is incidental to the operation of the taxpayer's trade or business.
The rental income is business income.
{28} Champion admits its
rental operations fall under this example. However, it claims that the
conclusion given -- "the rental income is business income" -- is
"illogical" because an identical Indiana regulation reaches an
opposite conclusion.
{29} It is not
"illogical" because the States of Arkansas, Idaho, Nebraska, North
Dakota, Oregon and Utah, all parties to the Multistate Tax Compact, reach the
same conclusion with this example as does New Mexico.
{30} Nevertheless, we reach
our holding in favor of the Commissioner without reliance on Regulation
17(b)(1).
{31} Champion obtained the
raw materials for its manufacture of wood and paper products from timber on
land owned or leased by it. Some of its logs were sold to telephone utilities
for use as telephone poles. The gain on the sale of logs was $4,803,652. The
tax consultant testified that since total sales were $1,339,000,000 the four
million "is a drop in the bucket". Even "a drop in the
bucket" must be apportioned if it is "business income". Again,
however, Champion claims an exemption, because it is not in the business of
selling logs for telephone poles. The sale of logs was a normal, customary
procedure in the business of Champion for the year 1972 and had been for
several years. The income arising therefrom was "income arising from
transactions and activity in the regular course of the taxpayer's trade or business".
Substantial evidence supports the Commissioner's decision that this income was
business income.
{*416} (2)
Champion's IRC § 631(a) gain was correctly apportioned as business income.
{32} Section 631(a) [26
U.S.C.A. § 631] of the Internal Revenue Code allows a taxpayer to elect to
treat the cutting of timber as a sale or exchange, eligible for taxation at
capital gains rates, even though the timber which has been cut has not actually
been sold.
{33} On its 1972 federal tax
return, Champion reported as a sale or exchange, the fair market value of
$950,669 worth of timber cut during 1972, but which remained unsold at the end
of that year.
{34} New Mexico does not
afford capital gains treatment to taxpayers. Therefore, Champion deducted the
fair market value of unsold timber from its business income on its New Mexico
tax return because it was not in fact
realized by timber sales in 1972.
The Commissioner disallowed the deduction. We agree.
(a) The cutting of timber which is unsold does not create
"income" within any accepted definition of that term.
(b) New Mexico is imposing a tax on an out-of-state activity.
This is both unconstitutional and beyond the taxing authority of the State.
(a) Timber-cutting gain for federal income tax is subject
to New Mexico income tax.
{37} Section 72-15A-3 of the
"Income Tax Act" says:
A tax is hereby imposed... upon the net income of... every
foreign corporation... engaged in the transaction of business in... this state.
{38} Sections 72-15A-2(S) and
(T)(2) says:
S. "base income" means that part of the taxpayer's
income generally defined as federal taxable income and upon which the
federal income tax is calculated; and
T. "net income" means base income adjusted to
exclude:
(2) amounts that the state is prohibited from taxing because
of the laws or Constitution of this state or the United States.... [Emphasis
added].
{39} We agree that § 631(a)
gain does not fit into ordinary definitions of income. See 85 C.J.S. Taxation §
1096a; 71 Am. Jur.2d State and Local Taxation 483. But a state has the power to
gauge its income tax by reference to the income on which the taxpayer is
required to pay a tax to the United States. The constitutionality of state
statutes which refer to the Internal Revenue Code definitions have been upheld
by the courts. See,
Garlin v. Murphy, 51 Misc.2d 477, 273 N.Y.S.2d 374
(1966), aff'd 34 N.Y.2d 921, 359 N.Y.S.2d 552 (1974);
Thorpe v. Mahin,
43 Ill.2d 36, 250 N.E.2d 633 (1969); 85 C.J.S. Taxation § 1096b; Annot.,
Constitutionality, construction, and application of provisions of state tax law
for conformity with Federal income tax law or administrative and judicial
interpretation, 166 A.L.R. 516 (1947), supplemented in 42 A.L.R.2d 797 (1955)
and its supplement.
{40} Champion elected to make
this § 631(a) gain a part of its federal taxable income for 1972. By use of
this gain, its federal income tax was calculated. Under the terms of §
72-15A-2(S), the gain is includable in Champion's base income for New Mexico
income tax purposes.
(b) New Mexico is not taxing an out-of-state activity.
{41} New Mexico has not
specifically taxed the § 631(a) gain. It has included that gain in the
apportionable business income of Champion. From this business income, New
Mexico can tax a percentage like the other states that are parties to the
Multistate Tax Compact.
{42} The tax is not levied on
the particular business activity of a taxpayer carried on within the borders of
the taxing state. The tax is levied on a percentage of the
{*417}
taxpayer's business income from
all its business activity. The
purpose of this scheme is to make uniform the tax laws of the participating
states.
{43} The Commissioner's
decision does not tax out-of-state activity. Neither does the tax statute. The
taxation is not beyond the State's taxing authority.
{44} Champion's claim of
unconstitutionality based on taxation of out-of-state activity, and its claim
that the imposition of the tax is beyond the taxing authority of New Mexico,
are both groundless.
(c) Courts uphold inclusion of unrealized gain within
"net income" for state taxation.
{45} The position we take on
state taxation of unrealized gain declared as federal taxable income is upheld
by the courts. The unrealized gain can be included in "net income"
for state tax purposes.
Garlin v. Murphy, supra;
Marco Associates,
Inc. v. Comptroller of Treasury, 265 Md. 669, 291 A.2d 489 (1972);
Commonwealth
v. Electrolux Corporation, 362 Pa. 333, 67 A.2d 105 (1949);
Ebling Co.
v. Graves, 259 App. Div. 427, 20 N.Y.S.2d 123, aff'd without opinion, 284
N.Y. 688, 30 N.E.2d 726 (1940).
WOOD, C.J., and LOPEZ, J., specially concur.
WOOD, Chief Judge (specially concurring).
{48} I do not join in Judge
Sutin's remarks concerning Champion's presentation at the administrative
hearing. I do not join in the references to I.T. Regulation 17(b) because that
regulation does not apply to the tax year in question.
{49} One issue in this case
is whether income from investments, rentals and sale of logs was business
income. Under § 72-15A-17(A), supra, it was business income if it arose in the
regular course of Champion's business. I do not agree that "regular
course" of business is to be determined by whether the business is
"unitary" or "one integral business". Such an approach
ignores the wording of the statute. Thus, I do not join in Part A of Judge
Sutin's opinion.
{50} My approach to the
meaning of "regular course" of "trade or business" differs
somewhat from the approach taken by Judge Sutin in Part B of his opinion. The
taxpayer's evidence makes it clear that the contested income was acquired in the
"regular course" of Champion's activities. I do not understand
Champion to contend otherwise. Champion's contention is that the contested
income was not acquired in the regular course of
trade or business.
{51} Champion takes a narrow
view of the meaning of trade or business. It would limit the meaning of trade
or business to the main course of its business which it asserts is
"manufacturing and selling finished products". It contends it is not
in the business of investments, of renting property or making occasional sales
of logs for use as telephone poles. Support for its view is found in Peters,
"The Distinction Between Business Income and Nonbusiness Income", 25
S. Cal. Law Center Tax Institute 251 (1973).
{52} The narrow view urged by
Champion is not supported by the
wording of UDITPA. Statutes are to be
given effect as written.
Keller v. City of Albuquerque, 85 N.M. 134,
509
P.2d 1329 (1973). Section 72-15A-17(A), supra, makes no reference to "main
business" or "main course of business". As I read §
72-15A-17(A), supra, it makes no difference whether the income derives from the
main business, the principal business, the occasional business or the
subordinate business so long as the income arises from the "regular
course" of business.
{53} Peters, supra, at 278
states: "Although one may quibble with the propriety of referring to
income realized by a business organization as nonbusiness income, it is utterly
ridiculous to assume that its meaning is limited to gifts or other receipts
{*418} having no connection with a profit
motive." I agree. In
Sperry and Hutchinson Co. v. Department of
Revenue, supra, interest on long-term and short-term securities held for
investment were non-business income because the interest did not arise from
transactions in the regular course of business. In
Western Natural Gas
Company v. McDonald, supra, income from a liquidation sale of oil and gas
leases was nonbusiness income because the sale was not made in the regular
course of business. Thus, all income of a business organization is not
"business income"; business income must arise from the regular course
of business.
{54} Pertinent in determining
whether income arises from transactions in the regular course of business is
"the nature of the particular transaction" and "former
practices" of the business entity.
Western Natural Gas Company v.
McDonald, supra. Also pertinent is how the income is used.
Sperry and
Hutchinson Co. v. Department of Revenue, supra.
{55} Judge Sutin's opinion
reviews the evidence. That evidence supports the Commissioner's conclusion that
interest income from short-term investments, income from renting surplus
property, and income from sale of logs was income arising in the regular course
of Champion's business. Thus, I concur in the result reached as to these items.
{56} I join in that part of
Judge Sutin's opinion holding the gain on cut but unsold timber was
apportionable as business income because that gain was reported as federal
taxable income for the year in question.
LOPEZ, Judge (specially concurring).
{57} I agree with Part A of
Judge Sutin's opinion and with the conclusion of Part (B)(2)(a) that the §
631(a) gain reported by the taxpayer was properly taxed by New Mexico. I do not
agree with the reasoning employed in Part B of Judge Sutin's opinion, nor with
the reasoning employed in Chief Judge Wood's concurring opinion. My reasons for
preferring the approach of Part A of Judge Sutin's opinion will be outlined
below.
{58} It is my belief that
UDITPA does not require that all income of a multiform business be included in
the business income from which a state takes its apportioned share. The issue
might best be presented by the example of a corporation which manufactures and
distributes shoes in New Mexico, Texas, and Colorado. In addition to this
business, the corporation also makes a sizable profit from office buildings
which it owns and operates for rental purposes in New York. One approach New
Mexico could take to the rent received would be to ask whether it was customary
for the corporation to rent apartments. On finding that it was customary, the
rental income would be classified as business income from which New Mexico
would take its proportional share. This would appear to be Judge Sutin's
approach. Chief Judge Wood looks instead to the "regular course" of
the taxpayer's business; since the corporation regularly rents apartments, the
same result would be reached. My approach would be to determine whether the
business of renting offices in New York is "independent" of the
business of selling shoes. Guidance for the meaning of "independent"
should be sought in the law which has developed around the unitary business
concept. See e.g.,
Commonwealth v. ACF Industries, Inc., 441 Pa.129, 271
A.2d 273 (1970) and Keesling & Warren, The Unitary Concept in the Allocation
of Income, 12 Hast.L.J. 42 (1960).
{59} I find support for the
position I have taken in the Oregon case of
Sperry and Hutchinson v.
Department of Revenue, 527 P.2d 729 (Or.1974). In deciding how interest
from investments was to be classified, the court did not dispute that the
taxpayer's "customary" and "regular" practice was to make
these investments, but rather examined the relationship of these investments to
the business that the taxpayer conducted in Oregon.
{60} The proposition that
businesses are indivisible, and hence that all income from
{*419}
them is business income, goes far beyond the position taken by the Bureau
in this case, and in its regulations.
{61} For example, at the
hearing below, in response to a question from the taxpayer's representative as
to what nonbusiness income was, the Bureau's representative stated:
"Well, if you took that money out and invested in yachts
for an unrelated purpose or bought property not related to your business of
logging or whatever it is and you derived income from it, then it would be
non-business income."
{62} More significantly, the
Bureau's regulations, and the examples illustrating them, indicate that there
comes a point where the Bureau feels corporate activity is divisible. Thus, in
discussing when rental income is business income the Bureau uses the following
example:
"Example (iv): The Taxpayer operates a multistate chain
of grocery stores. It purchases as an investment an office building in another
state with surplus funds and leases the entire building to others. The net
rental income is not business income of the grocery store trade or business.
Therefore, the net rental income is nonbusiness income." I.T. Regulation
17(b)(I).
{63} Finally, constitutional
issues of due process come into play when the abolition of the distinction
between unitary and multiform businesses is proposed. Those Supreme Court cases
which have upheld formulary apportionment have done so on the basis that the
business taxed was a unitary business. Rudolph, State Taxation of Interstate
Business: The Unitary Business Concept and Affiliated Corporate Groups, 25 Tax
L. Rev. 171, 183-84, (1970); see, e.g.,
Butler Brothers v. McColgan, 315
U.S. 501, 62 S. Ct. 701, 86 L. Ed. 991 (1942). Although I have found no Supreme
Court cases stating that the multiform concept must be respected by state
taxing authorities (there are state court cases so holding; see, e.g.,
Hamilton
Management Corporation v. State Tax Commission, 253 Or. 602, 457 P.2d 486
(1969)). I think that a serious constitutional problem is presented by the
failure to distinguish between that income of a business originating in the
taxing state, and that income which has no real relationship to that state.
{64} Judge Sutin correctly
states that we simply cannot tell from the record before us which of the
contested items have no connection with New Mexico. Therefore, although my
different interpretation of UDITPA may lead to disagreement in future cases, I
have no quarrel with the result reached today.