Lead Opinion
Opinion
States have long struggled to devise an equitable and constitutional method for taxing corporations that do business in multiple states and countries. Like many other states, California has adopted the Uniform Division of Income for Tax Purposes Act (7A pt. 1 West’s U. Laws Ann. (1999) U. Div. of Income for Tax Purposes Act, § 1 et seq., p. 361) (UDITPA) in an attempt to resolve this dilemma (see Rev. & Tax. Code, §§ 25120-25141).
Hoechst Celanese Corporation (Hoechst), formerly Celanese Corporation, is a Delaware corporation with its principal place of business in New Jersey and its commercial domicile in New York. It manufactures and sells a diversified line of chemicals, fibers and specialty products. Since the late 1960’s, Hoechst has conducted business operations in California and filed California franchise tax returns.
In 1947, Hoechst created its first pension plan. Since then, Hoechst’s pension plans have undergone numerous changes. For example, the original pension plan required contributions from both Hoechst and its participating employees. In 1969, however, the plan became noncontributory, and only Hoechst had to make contributions. Despite the constant evolution of these plans, their purpose has remained the same. Hoechst has created and maintained these plans “for the general benefit of its employees” in an effort to “retain its current employees and to attract other qualified employees.”
The version of the pension plan at issue here was known as the Celanese Retirement Income Plan (CRIP I), and was subject to the terms of the Employee. Retirement Income Security Act of 1974 (29 U.S.C. § 1001 et seq.) (ERISA). CRIP I dated back to the original 1947 plan and resulted from the merger in 1982 of several pension plans created and maintained by Hoechst and its controlled subsidiaries. It was a qualified plan under Internal Revenue Code section 401(a) (26 U.S.C. § 401(a)) and covered both active and retired employees. Under the terms of CRIP I, each plan member only had a “nonforfeitable right” to a predefined level of benefits. (Hughes Aircraft Co. v. Jacobson (1999)
In conjunction with CRIP I, Hoechst created and maintained a trust known as the Celanese Retirement Income Plan Trust (CRIP Trust I). The trust was tax exempt, and Chase Manhattan Bank acted as the trustee. To fund CRIP I, Hoechst made periodic contributions to the CRIP Trust I, and the trust invested these contributions in order to ensure adequate funding for the pension plan. These contributions discharged Hoechst’s financial obligations and liabilities to CRIP I subject to any limitations imposed by ERISA. As permitted by law, Hoechst claimed tax deductions for these contributions on its federal and California tax returns. Any surplus assets in excess of those necessary to meet any obligations and liabilities owed under ERISA and CRIP I (surplus pension plan assets) were used to reduce future contributions by Hoechst to the CRIP Trust I and were not used to increase any benefits provided under the plan.
Because the CRIP Trust I held the pension plan assets, Hoechst did not own or hold legal title to these assets and could not use these assets to fund any of its corporate activities. Hoechst, however, retained an interest in any surplus pension plan assets. These surplus assets would revert to Hoechst only upon termination of the plan and satisfaction of all benefits and liabilities owed under CRIP I and ERISA. Until such a reversion, none of the pension plan assets, including any contributions or capital gains, were taxable as Hoechst’s income.
Even though Hoechst did not hold legal title to the pension plan assets, it did have some control over them through its power over CRIP I and the CRIP Trust I and their predecessors. For example, Hoechst had the power to amend or discontinue the pension plans at any time, subject to ERISA limitations. The board of directors of Hoechst also had the power to
Hoechst also retained the power to administer its pension plans, including the power to prescribe procedures to follow in obtaining evidence necessary to establish the right of any person to payments under the plans, to interpret the terms of the plans, to prescribe procedures for determining and recording the periods for calculating benefits, and to determine the right of any person to benefits under the plans. To exercise these powers, Hoechst created an administrative committee composed of Hoechst employees, including corporate officers. Known as the Employee Benefits Administration Committee, the committee handled all paperwork for the plans, determined eligibility for benefits and considered requests for increases in benefits. The committee met in either New York or North Carolina three to six times a year on an irregular basis, depending on the rate that applications accumulated.
Hoechst also created a separate committee responsible for the supervision and review of the financial operation of its pension plans and trusts. The Celanese Pension Plan Investment Committee was comprised of Hoechst’s chief financial officer, some of its vice-presidents, its controller and an individual from its human resources department. The committee established, supervised and reviewed the funding and investment policies of the plans and trusts and appointed the investment fund managers who determined the actual investments made by the plans and trusts. Although the committee did not control the specific investments chosen by the fund managers, it had the power to change fund managers and guide their overall investment strategy. On many occasions, Hoechst exercised this power and replaced these fund managers for various reasons, including inadequate performance. For example, in 1978, the committee “drastically revised” the investment strategy of its pension plan and “introduced new managers with a different perspective on their mission.”
Due to years of wise investments, the CRIP Trust I accumulated more assets than necessary to fund the defined benefits owed to plan members under CRIP I and ERISA. In 1983, Hoechst decided to recapture these surplus assets in order to preclude their use in a takeover bid. To recapture the surplus assets, Hoechst divided CRIP I into two separate plans with essentially the same provisions as CRIP I. The newly created Celanese Retirement Income Plan (CRIP II) covered active employees, and the Celanese Retirement Security Plan (CRSP) covered retired employees. Like their predecessor, both plans were qualified benefit plans under Internal Revenue Code section 401(a).
Concurrent with its division of CRIP I, Hoechst divided the CRIP Trust I into two separate trusts. The Celanese Retirement Income Plan Trust (CRIP Trust II) funded the newly created CRIP II, while the Celanese Retirement Security Plan Trust (CRSP Trust) funded the newly created CRSP. As part of the split-up, Hoechst allocated all assets of the CRIP Trust I between the CRIP Trust II and the CRSP Trust. In making this allocation, Hoechst made sure that all benefits owed to CRIP II and CRSP members were fully funded as required under the terms of CRIP I and ERISA.
Using the funds allocated to the CRSP Trust, Hoechst purchased annuities to provide the benefits owed to its retirees. Hoechst then terminated both CRSP and the CRSP Trust in 1985. Upon termination, all surplus assets of that plan and trust reverted to Hoechst. This surplus
As part of its 1985 federal tax returns, Hoechst reported the income from the reversion as “miscellaneous income.” Hoechst also reported the income from the reversion as “taxable income of the business” in its 1985 New York tax return, and paid New York state income tax on a small percentage of this income.
Hoechst filed a timely protest. The Board denied the protest and affirmed the proposed assessment in its entirety. Hoechst then appealed to the State Board of Equalization (SBE). Citing Appeal of Borden, Inc. (Feb. 3, 1977) (1971-1978 Transfer Binder) Cal.Tax Rptr. (CCH) paragraph 205-515, page 14,897-57 (Borden), and Appeal of Kroehler Manufacturing Co. (Apr. 6, 1977) (1971-1978 Transfer Binder) Cal.Tax Rptr. (CCH) paragraph 205-646, page 14,897-122 (Kroehler), the SBE held that: (1) the definition of “business income” in subdivision (a) of section 25120 created both a transactional and a functional test; and (2) income from the reversion was business income under the functional test. Thus, the reverted income was apportionable and subject to taxation in California. The SBE also found the tax assessment constitutional under the operational purpose test enunciated in Allied-Signal, Inc. v. Director, Div. of Taxation (1992)
Hoechst then filed a timely claim for refund with the Board. As part of the claim, Hoechst attached a check for $715,791.35—which covered the original assessment plus interest. In the claim, Hoechst asked for a full refund, alleging that the income from the reversion did not constitute business income under section 25120. Hoechst further argued that apportionment of the income from the reversion to California violated the due process and commerce clauses of the United States Constitution.
After the Board denied the claim, Hoechst filed a complaint for refund of taxes with the superior court. After a hearing, the court ruled in favor of the Board. Specifically, the court found that: (1) the statutory definition of “business income” established both a transactional and a functional test; (2) the income from the reversion was apportionable business income subject to taxation in California under the functional test; and (3) taxation of the income from the reversion by California did not violate the due process and commerce clauses of the United States Constitution.
Hoechst appealed, and the Court of Appeal reversed. Although the court applied both a transactional and functional test, it concluded that the reversion did not satisfy either test. First, the court found that the reversion did not meet the transactional test because the reversion was an extraordinary event that did not occur in the regular course of Hoechst’s trade or business. Second, the court found that the reversion failed the functional test because Hoechst did not own or hold title to the pension plan assets that generated the income.
We granted review to determine whether: (1) income from a reversion of surplus pension plan assets constitutes business income apportionable to California; and (2) subjecting income from a reversion to taxation in California violates the federal due process and commerce clauses.
Discussion
I
Pursuant to “the unitary business principle,” a state may “tax a corporation on an apportionable share of the multistate business carried on in part in the taxing State.” (Allied-Signal, supra,
Originally promulgated by the National Conference of Commissioners on Uniform State Laws (Commissioners) in 1957, the UDITPA has two main objectives: “(1) to promote uniformity in allocation practices among the 38 states which impose taxes on or measured by the income of corporations, and (2) to relieve the pressure for congressional legislation in this field.” (Keesling & Warren, California’s Uniform Division of Income for Tax Purposes Act (1967) 15 UCLA L.Rev. 156, 156 (Keesling & Warren).) Initially, the UDITPA received a tepid response as few states adopted it. In 1965, however, Congress proposed comprehensive legislation regulating state taxation of interstate commerce. Spurred by the specter of congressional intervention, many states, including California, adopted the UDITPA. (See Peters, The Distinction Between Business Income and Nonbusiness Income (1973) 25 So.Cal. Tax Inst. 251, 279 (Peters).) Currently, 22 states plus the District of Columbia have adopted the UDITPA.
California’s Uniform Division of Income for Tax Purposes Act (California UDITPA)
Because section 25120 defines “nonbusiness income” in relation to business income, the definition of “business income” is the key to determining whether corporate income is apportionable or allocable. To construe this definition, we apply the well-established rules of statutory construction and seek to “ ‘ascertain the intent of the Legislature so as to effectuate the purpose of the law.’ ” (Wilcox v. Birtwhistle (1999)
In the instant case, Hoechst contends the statutory definition of “business income” creates a single transactional test, and the 1985 reversion of surplus pension plan assets does not satisfy this test or any other test. Thus, the income from the reversion is nonbusiness income that is only taxable by Hoechst’s commercial domicile, New York. The Board counters that the definition establishes both a transactional and functional test, and the reversion meets both tests. Thus, the reverted assets are apportionable to California. As explained below, we conclude that the statutory definition establishes separate transactional and functional tests for business income and that the reversion satisfies only the functional test. Therefore, the income from the reversion is apportionable business income.
A. The Business Income Tests
Subdivision (a) of section 25120 states: “ ‘Business income’ means income arising from transactions and activity in 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.” Thus, the statutory definition of “business income” consists of two clauses joined together by the conjunction and predicate, “and includes.” (Ibid.) In interpreting this language, all courts agree that the first clause establishes a transactional test. Some courts have, however, construed the second clause as a separate functional test for business income. (Uniroyal Tire Co. v. Dept. of Finance (Ala. 2000)
We initially note that the statutory language is ambiguous and reasonably susceptible to either interpretation. On the one hand, the grammatical structure of the business income definition arguably creates both a transactional and functional test. “Business income” is the subject of the sentence. (§ 25120, subd. (a).) Two predicate clauses containing different verbs, objects and prepositional phrases and separated by a conjunction follow this subject. As such, the definition arguably contains a “compound predicate” that states two independent definitions of business income. (Kroger, supra, 613 N.E.2d at p. 713.) In other words, “the statute could grammatically be read as stating: ‘Business income means income arising from transactions and activity in the regular course of the corporation’s trade or business, and [business income] includes income from tangible and intangible property (Polaroid, supra,
On the other hand, the addition of the word “includes” after the conjunction linking the two clauses suggests that the second clause is a subset of the first clause under the last antecedent doctrine. (See § 25120, subd. (a).) According to this doctrine, “ ‘qualifying words, phrases and clauses are to be applied to the words or phrases immediately preceding and are not to be construed as extending to or including others more remote.’ ” (White v. County of Sacramento (1982)
The language of the second clause provides some support for such an interpretation. The second clause states that the “acquisition, management, and disposition” of property must be “integral parts” of the taxpayer’s “regular” “business operations.” (§ 25120, subd. (a), italics added.) The use of “and” suggests that the second clause merely exemplifies the first because the sale of property “ ‘that is not regularly disposed of, but rather is held indefinitely,’ ” arguably cannot be an integral part of the taxpayer’s business operations. (Uniroyal Tire, supra,
Moreover, the apparent breadth of the second clause equally supports the rejection of the functional test. As the Alabama Supreme Court observed: “If income is business income under the transactional test, then, a fortiori, it is business income under the functional test. In other words, the functional test would include everything that the transactional test includes—and much more.” (Uniroyal Tire, supra, 779 So.2d at pp. 235-236.) As such, construing section 25120 to create two alternative tests for business income arguably renders the first clause mere surplusage, in violation of the rules of statutory construction. (See People v. Cruz (1996)
In light of these competing arguments, we conclude that the statutory language is ambiguous as to the existence of a separate functional test. At a minimum, we
As an initial matter, the legislative history behind the UDITPA strongly supports the inclusion of a functional test. Because the Legislature adopted the UDITPA almost verbatim (Keesling & Warren, supra, 15 UCLA L.Rev. at p. 156), we look to the history behind the UDITPA for guidance (see Bonds, supra, 24 Cal.4th at pp. 16-19). This history reveals that the UDITPA definition of “business income” derives from “California decisional law” which employed a separate functional test for business income. (Peters, supra, 25 So.Cal. Tax Inst. at p. 278.)
The first draft of the UDITPA did not distinguish between business and nonbusiness income. (Peters, supra, 25 So.Cal. Tax Inst, at pp. 272-273.) After concerns about the constitutionality of the first draft arose, John S. Warren, a California tax administrator, suggested that the Commissioners divide all income into apportionable business income and allocable nonbusiness income. As part of his suggestion, Warren proposed a definition of business income based on language used in certain SBE decisions. (Id. at pp. 275-276.) The Commissioners liked Warren’s proposal, and “[t]he final draft of the [UDITPA] contained the definitions of business income and nonbusiness income proposed by Mr. Warren.” (Peters, supra, at p. 276.) Thus, the UDITPA’s definition of business income was based on pre-UDITPA decisions of the SBE, and the UDITPA’s distinction between business and nonbusiness income was “in line with . . . California practice” at the time of its enactment. (Keesling & Warren, supra, 15 UCLA L.Rev. at pp. 163-164; see also Polaroid, supra,
These SBE decisions consistently applied an independent functional test when determining whether income constituted business income. In doing so, the SBE
The comments to section 1, subdivision (a) of the UDITPA prepared by the Commissioners (Commissioners Comments) bolster our holding. The comment states in part that “[i]ncome from the disposition of property used in a trade or business of the taxpayer is includible within the meaning of business income.” (Comrs. Corns., UDITPA, com. foil. § 1, subd. (a), p. 2, reprinted at <http://www.law.upenn.edu/bll/ulc/fnact99/ 1920_69/udiftp57.htm> [as of May 14, 2001].) By focusing on the “property” and its relationship to the “trade or business” and using the “disposition” language of the second clause {ibid..), the Commissioners’ comment strongly suggests that a separate functional test for business income exists. Indeed, the comment ostensibly makes all income from the disposition of property used in the taxpayer’s business apportionable even if the disposition does not occur “in the regular course of the taxpayer’s trade or business.” (7A pt. 1 West’s U. Laws Ann., supra, UDITPA, § 1, subd. (a), pp. 361-362.)
Administrative decisions interpreting the statutory definition of “business income” also support the inclusion of a separate functional test. Although we are not bound by administrative decisions construing a controlling statute, we accord “ ‘great weight and respect to the administrative construction.’ ” (Yamaha Corp. of America v. State Bd. of Equalization (1998)
In
Finally, construing the second clause of the definition as a separate functional test fulfills one of the primary objectives
B. The Transactional Test
Under the transactional test, corporate income is business income if it arises “from transactions and activity in the regular course of the taxpayer’s trade or business.” (§ 25120, subd. (a).) Upon construing and applying this statutory language, we conclude that Hoechst’s reversion of surplus pension plan assets fails to meet the transactional test.
The language of the transactional test is unambiguous, and courts have construed this language in a consistent manner. “The controlling factor by which” the transactional test “identifies business income is the nature of the particular transaction” that generates the income. (Western Natural Gas, supra,
Here, the reversion and the activities necessary to execute the reversion were extraordinary occurrences. They were not normal trade or business activities of Hoechst, which manufactured and sold a diversified line of chemicals, fibers and specialty products. Indeed, the 1985 reversion of surplus pension plan assets was the first and only such transaction in Hoechst’s corporate history. Because the reversion was a “once-in-a-lifetime corporate occurrence,” it cannot meet the transactional test. (Phillips Petroleum, supra, 511 N.W.2d at pp. 610-611.)
In reaching this conclusion, we reject the Board’s attempt to define the relevant “transactions and activity” as the purchase and sale of securities by the fund managers appointed by Hoechst. (§ 25120, subd.
C. The Functional Test
Under the functional test, corporate income is business income “if the acquisition, management, and disposition of the [income-producing] property constitute integral parts of the taxpayer’s regular trade or business operations.” (§ 25120, subd. (a).) After reviewing the statutory language and the applicable extrinsic aids, we hold that the reversion satisfies the functional test. Therefore, the income from the reversion is business income apportionable to California.
We begin our analysis by examining the statutory language. In contrast to the transactional test, which focuses on the income-producing “transactions and activity,” the functional test focuses on the income-producing “property.” (§ 25120, subd. (a).) This property may be “tangible” or “intangible” (ibid.), and the nature of the relationship between this property and the taxpayer’s “business operations” is the critical inquiry (Texaco-Cities, supra,
Before defining the relationship necessary to meet the functional test, we reject at the outset Hoechst’s contention that the statutory term “property” implies that the taxpayer must own or hold legal title to the property. Such an interpretation only considers the term “property” in isolation and ignores the conditional clause that places this term in context: “if the acquisition, management, and disposition of the property constitute integral parts of the taxpayer’s regular trade or business operations.” (§ 25120, subd. (a), italics added.) This conditional clause—and not the vague implications of the term “property”—defines the relationship between the property and the taxpayer required by the functional test.
The conditional clause contains two key phrases: “acquisition, management, and disposition of the property” and “integral parts of the taxpayer’s regular trade or business operations.” (§ 25120, subd. (a).) The first phrase— “acquisition, management, and disposition of the property”—appears to refer to the taxpayer’s interest in and power over the income-producing property. (Ibid.) In construing this phrase, the parties focus on the meaning of the word “and.” (Ibid.) Hoechst contends “and” has a conjunctive meaning, while the Board contends “and” has a disjunctive meaning in the statute. (Ibid.) Because “and” is ordinarily conjunctive and because nothing suggests a legislative intent to give “and” a different meaning, we agree with Hoechst. (See Wilcox, supra,
Upon doing so, we conclude that the phrase “acquisition, management, and disposition” “refers to the conditions of ownership of property by the taxpayer.” (Kroger, supra,
Under this construction, legal ownership or title to the property is not necessary. Such a limitation is too restrictive because property ownership “finds expression through multiple methods.” (Union Oil Co. v. State Bd. of Equal. (1963)
The Commissioners Comments to the UDITPA confirm our belief. In the comment to section 1 of the UDITPA, the Commissioners state that “[income from the disposition of property” is business income if the property is “used in a trade or business of the taxpayer.” (Comrs. Corns., UDITPA, com. foil. § 1, subd. (a), p. 2, reprinted at <http://www.law.upenn.edu/bll/ulc/ fnact99/1920_69/udiftp57.htm> [as of May 14, 2001], italics added.) In making this statement, the Commissioners clearly contemplated that the functional test would focus on the taxpayer’s control and use of the property and not on legalistic formulations of property ownership.
Of course, mere control and use of the income-producing property is not enough to satisfy the functional test. Rather, the taxpayer’s control and use of the property must still be an “integral part[] of the taxpayer’s regular trade or business operations.” (§ 25120, subd. (a).) The critical terms in this second key phrase of the functional test are “integral,” “regular,” and “operations.” (Ibid.) As explained below, these terms establish that the taxpayer’s control and use of the property must contribute materially to the taxpayer’s production of business income so that the property becomes interwoven into and inseparable from the taxpayer’s business.
We begin our interpretation of this phrase by defining the terms “regular” and “operations.” “[RJegular” means “Normal” or “Typical.” (Webster’s 3d New Internat. Dict., supra, at p. 1913.) In the business context, “operations” mean “the whole process of planning for and operating a business” or “a phase of a business or of business activity.” (Id. at p. 1581.) As such, the phrase “regular trade or business operations” is unambiguous
To reach this conclusion, we reject Hoechst’s contention that the word “regular” limits the functional test to normal or customary corporate events. Although “regular” has the same meaning in the transactional and functional tests, it is not used in the same way in these tests. In the transactional test—which focuses on the income-producing transaction—“regular” modifies “course of the taxpayer’s trade or business” and makes the nature of the transaction relevant. (Associated Partnership I, supra,
Thus, the phrase “regular trade or business operations” (§ 25120, subd. (a)) establishes that the taxpayer’s control and use of the income-producing property must be part of the taxpayer’s normal or typical business activities. The statutory term “integral” then provides the touchstone for determining whether the property has a close enough relationship to the taxpayer to satisfy the functional test. (Ibid.) Not surprisingly, the parties disagree over the meaning of “integral.” (Ibid.) Hoechst contends “integral” means “necessary or essential to.” The Board counters that “integral” only means “contributing to.” We, however, find neither interpretation to be accurate. Instead, we hold that “integral” requires an organic unity between the taxpayer’s property and business activities whereby the property contributes materially to the taxpayer’s production of business income.
As an initial matter, we note that the dictionary definition of “integral” arguably supports both parties’ positions. As defined by Webster’s Third International Dictionary, supra, at page 1173, “integral” means “of, relating to, or serving to form a whole: essential to completeness: organically joined or linked: Constituent, Inherent.” (Italics added.) The relevant case law also lends support to both interpretations. On the one hand, we have suggested that “integral” means “ ‘dependent upon or contributes to’ ” in the multistate taxation context. (Superior Oil Co. v. Franchise Tax Bd. (1963)
Nonetheless, we believe that both interpretations are problematic and do not capture the true meaning of “integral.” (§ 25120, subd. (a).) Construing “integral” as “contributing to” makes the test
Thus, the meaning of “integral” must fall somewhere in between these two interpretations. In forging this middle ground, we once again look to the SEE decisions underlying the functional test for guidance. (See ante, at pp. 524-525; see also Keesling & Warren, supra, 15 UCLA L.Rev. at pp. 163-164; Polaroid, supra,
In the context of the business income definition, the word “integral” therefore refers to an “organic unity” between the income-producing property and the taxpayer’s business activities. (Holly Sugar, supra,
Forming these interpretations of the statutory language into a cohesive
We further note that our interpretation is consistent with Court of Appeal decisions applying the functional test. For example, the Court of Appeal has found business income where the income-producing property contributed materially to the taxpayer’s production of business income. In Citicorp, the court held that income from a taxpayer’s sale of buildings constituted business income under the functional test because “the buildings were constructed or acquired to serve as important locations for [the taxpayer’s business] operations.” (Citicorp, supra, 83 Cal.App.4th at pp. 1429-1430.) Thus, the court premised its finding of business income on the buildings’ material contribution to the taxpayer’s production of business income and concluded that the buildings were an indivisible part of the taxpayer’s business operations. (See ibid.; see also Times Mirror Co. v. Franchise Tax Bd. (1980)
In contrast, the Court of Appeal has found nonbusiness income where the taxpayer’s control and use of the property did not contribute materially to the generation of business income. In Robert Half, the court found that losses incurred from the repurchase of a stock warrant constituted nonbusiness income. (Robert Half, supra,
Our interpretation of the functional test also accords with the SBE’s interpretation over the past two decades. On the one hand, the SBE has consistently found business income under the functional test where the taxpayer’s control and use of the property contributed materially to the production of business income and became an indivisible part of the taxpayer’s business. For example, the SBE found that losses from the sale of goodwill constituted business income because the taxpayer’s acquisition and maintenance of this goodwill “contributed materially to the production of business income.” (Borden, supra, [1971-1978 Transfer Binder] Cal.Tax Rptr. (CCH) H 205-616, p. 14,897-59.) The SBE also held that compensation received for the loss of exclusive territorial rights constituted business income because these rights were “an important aspect of the business” and “contributed materially to the production of business income.” (New York Football Giants, supra, [1971-1978 Transfer Binder] Cal.Tax Rptr. (CCH) T[ 205-600, p. 14,897-33.) Similarly, the SBE found that dividends from a joint venture were business income because these ventures “contributed materially to the production of operating income . . . and clearly served to further the operation of’ the taxpayer’s business.
On the other hand, the SBE has consistently refused to find business income under the functional test where the taxpayer’s control and use of the property did. not contribute materially to the production of business income and were separate from the taxpayer’s business. For example, the SBE found that rental income from a condominium constituted nonbusiness income because the rental business had no connection to the taxpayer’s architectural business. (Amwalt Group, supra, [1981-1984 Transfer Binder] Cal.Tax Rptr. (CCH) ^ 400-433, p. 22,696.) Similarly, the SBE held that income from the sale of stock in a company constituted nonbusiness income where the taxpayer exercised no control over and received no special benefits from that company. (Mark Controls, supra, [1986-1990 Transfer Binder] Cal.Tax Rptr. (CCH) H 401-452, p. 24,569.) Finally, the SBE held that property used to obtain tax benefits did not give rise to business income because the property did not contribute to the production of business income and was not connected to any business activity of the taxpayer. (VSI Corp., supra, [1991-1992 Transfer Binder] Cal.Tax Rptr. (CCH) H401-937, pp. 26,241 to 26,242; National Dollar Stores, supra, [1984-1986 Transfer Binder] Cal.Tax Rptr. (CCH) H 401-403, p. 24,432.)
Finally, our interpretation is largely consonant with the decisions of other jurisdictions that have adopted the functional test. These jurisdictions have focused on the taxpayer’s use of the property and typically find business income where the taxpayer uses that property to produce business income. (See, e.g., Pierce Associates, supra,
Having established the contours of the functional test, we now apply it to Hoechst’s reversion of surplus pension plan assets and conclude that the reversion meets this test. In reaching this conclusion, we find two SBE decisions instructive. In Appeal of American Snuff Co.
Taken together, these decisions establish that property maintained and used by a taxpayer to retain and attract employees is integral to the taxpayer’s business operations. Although these decisions are not binding, we find them especially persuasive because of their longevity, consistency and reasoning. (See Yamaha, supra, 19 Cal.4th at pp. 12-14.) Indeed, American Snuff-—which predates the California UDITPA—is arguably controlling because the Legislature presumably enacted the UDITPA with the understanding that it did not alter existing California law. (See Keesling & Warren, supra, 15 UCLA L.Rev. at pp. 163-164 [the UDITPA’s distinction between business and nonbusiness income “is in line with . . . existing California practice”].) Moreover, at least one other state court applying the functional test has applied similar reasoning to reach a similar conclusion. (See American Smelting, supra,
In light of the reasoning of these decisions, the income from Hoechst’s reversion of surplus pension plan assets constitutes business income under the functional test. Hoechst created the income-producing property—the pension plan and trust—in order to retain its current employees and to attract new employees. Hoechst had “broad authority to amend [the] plan” (Hughes Aircraft, supra,
In reaching this conclusion, we recognize that Hoechst did not own or hold legal title to the pension plan assets, and that ERISA imposed many restrictions on Hoechst’s control and use of these assets. (See Shaw v. Delta Air Lines, Inc. (1983)
We further note that apportioning income from the reversion to California is equitable in light of the tax benefits received by Hoechst in connection with its control and use of the pension plan assets. Not only did Hoechst receive an operational benefit from its pension plan contributions, it also received a tax deduction for these contributions throughout the lifetime of the plans. Absent their use in the pension plans, these contributions would have been taxable as business income by California. Thus, Hoechst essentially received the. pension plans’ contribution to its California business operations tax free prior to its reversion of surplus pension plan assets. In fact, absent apportionment of the income from the reversion, Hoechst would receive a windfall because New York—Hoechst’s commercial domicile— taxed only a small percentage of the reverted income. Under these circumstances, subjecting income from the reversion to taxation in California is both fair and reasonable.
Finally, the absence of any reference to these pension plan assets in Hoechst’s financial statements is irrelevant. These omissions are the product of accounting standards in effect prior to 1985 and do not necessarily reflect the actual relationship between the assets and Hoechst’s business operations. In any event, national accounting standards adopted in 1985 now require “expanded disclosures intended to provide more complete and more current information” about pension plan assets in financial statements. (Fin. Acctg. Stds. Bd., Summary of Statement No. 87, Employers’ Accounting for Pensions (Dec. 1985) p. 3, at <http://www.rutgers.edu/Accounting/raw/fasb/st/ summary/stsum87.htm> [as of May 14, 2001].) The Financial Accounting Standards Board created these standards in an effort to make clearer the link between “pension plan finances” and “the corporations’ operations.” (Improving FAS 87 (Oct. 18, 1999) Pensions & Investments, p. 12.) Thus, the failure of Hoechst to report the earnings of its pension plan on its books of account has no bearing here.
We are mindful that the North Carolina Supreme Court reached a contrary conclusion in Union Carbide, supra,
II
Even though Hoechst’s reversion of surplus pension plan assets falls within the statutory definition of business income, subjecting the income from the reversion to taxation in California must still pass constitutional muster. Under the federal due process and commerce clauses, “a State may not tax value earned outside its borders.” (ASARCO, supra,
In limiting a state’s taxing power, courts “are guided by the basic principle that the State’s power to tax an individual’s or corporation’s activities is justified by the ‘protection, opportunities and benefits’ the State confers on those activities.” (Allied-Signal, supra,
In construing these constitutional limitations on a state’s taxing power, the
Here, the income-producing asset—the pension plan and trust— undoubtedly served an operational function for Hoechst. Hoechst funded the plan and trust with its apportionable business income. It managed the plan and trust by choosing the trustee and appointing a committee of its officers and employees to oversee the trust’s administration, to choose its investment managers, and to guide its overall investment strategy. More importantly, Hoechst created and maintained the plan and trust in order to induce its current employees to stay and to attract new employees. As such, the pension plan and trust undoubtedly helped Hoechst “make better use” of an important and existing business-related resource—its employees. (Container Corp., supra,
Disposition
We reverse the judgment of the Court of Appeal and remand for further proceedings consistent with this opinion.
George, C. J., Mosk, J., Kennard, J., Baxter, J., and Chin, J., concurred.
Notes
All further statutory references are to the Revenue and Taxation Code unless otherwise indicated.
New York has not adopted the UDITPA.
These states are: Alabama, Alaska, Arizona, Arkansas, California, Colorado, Hawaii, Idaho, Kansas, Kentucky, Maine, Michigan, Missouri, Montana, Nebraska, New Mexico, North Dakota, Oregon, South Dakota, Texas, Utah and Washington. (7A pt. 1 West’s U. Laws Ann. (2000 supp.) UDITPA, note, p. 13.)
Since 1993, the Legislature has amended the original apportionment formula—which used to be identical to the formula used in the UDITPA. (Compare § 25128 with Stats. 1966, ch. 2, § 7, p. 179.) The present formula, however, is still based on the property, sales and payroll of the taxpayer. (See § 25128.)
In three separate requests for judicial notice, the Board asked the court to take judicial notice of: (1) a bill analysis and fiscal impact report submitted by the New Mexico Taxation and Revenue Department in connection with New Mexico House Bill No. 349 (1999 Reg. Sess.); (2) a transcript of the January 12, 1996, hearing of the California Assembly Committee on Taxation; (3) the 1966 reprinting of the model UDITPA issued by the National Conference of Commissioners on Uniform State Laws; (4) the legislative history of Assembly Bill No. 11 (1966 Reg. Sess.), which became the California UDITPA; (5) a January 7,1966 memorandum from Allison Dunham, the Executive Director of the National Conference of Commissioners on Uniform State Laws, to the Special Committee on UDITPA; and (6) a January 21, 1966 memorandum from William J. Pierce, a commissioner of the National Conference of Commissioners on Uniform State Laws, to the Special Committee on UDITPA. In addition, Hoechst asked the court to take judicial notice of a January 14, 1966 memorandum from Donald H. Burnett to R.R. Bullivant, Chairman of the Special Subcommittee on UDITPA. We hereby grant these requests. (Evid. Code, § 452, subd. (h).)
Compare Uniroyal Tire, supra,
(See, e.g., Appeal of CTS Keene, Inc. (Feb. 10, 1993) [1993-1995 Transfer Binder] Cal.Tax Rptr. (CCH) H 402-589, p. 27,569; Appeal of Dial Finance Co. of Cal. (Feb. 10, 1993) [1993-1995 Transfer Binder] Cal.Tax Rptr. (CCH) ^ 402-586, p. 27,553; Appeal of American Biltrite Inc. (Nov. 19, 1992) [1991-1992 Transfer Binder] Cal.Tax Rptr. (CCH) H 402-531, p. 27,407-3; Appeal of VSI Corp. (May 2, 1991) [1991-1992 Transfer Binder] Cal.Tax Rptr. (CCH) H 401-937, p. 26,240 (VSI Corp.); Appeal of Masonite Corp. (Nov. 15, 1988) [1986-1990 Transfer Binder] Cal.Tax Rptr. (CCH) 401-677, p. 25,335; Appeal of R.H. Macy & Co. (July 26, 1988) [1986-1990 Transfer Binder] Cal.Tax Rptr. (CCH) 401-639, p. 25,195; Appeal of U-Haul Co. of Van Nuys (Mar. 3, 1987) [1986-1990 Transfer Binder] Cal.Tax Rptr. (CCH) H 401-489, p. 24,667; Appeal of Mark Controls Corp. (Dec. 3, 1986) [1986-1990 Transfer Binder] Cal.Tax Rptr. (CCH) U 401-451, p. 24,566 (Mark Controls); Appeal of National Dollar Stores, Inc. (Sept. 10, 1986) [1984-1986 Transfer Binder] Cal.Tax Rptr. (CCH) H 401-403, p. 24,429 (National Dollar Stores); Appeal of Armour Oil Co. (June 10, 1986) [1984-1986 Transfer Binder] Cal.Tax Rptr. (CCH) 1 401-355, p. 24,325; Appeal of Southwestern Development Co. (Sept. 10, 1985) [1984-1986 Transfer Binder] Cal.Tax Rptr. (CCH) Í 401-157, p. 23,898; Appeal of Calvo Growers of Cal. (Feb. 28, 1984) [1981-1984 Transfer Binder] Cal.Tax Rptr. (CCH) K 400-673, p. 23,035; Appeal of Johns-Manville Sales Corp. (Aug. 17, 1983) [1981-1984 Transfer Binder] Cal.Tax Rptr. (CCH) H 400-476, p. 22,741; Appeal of Amwalt Group, Inc. (July 28, 1983) [1981-1984 Transfer Binder] Cal.Tax Rptr. (CCH) H 400-433, p. 22,693 (Amwalt Group); Appeal of Occidental Petroleum Corp. (June 21, 1983) [1981-1984 Transfer Binder] Cal.Tax Rptr. (CCH) H 400-394, p. 22,609 (Occidental Petroleum); Appeal of Standard Oil Co. of Cal. (Mar. 2, 1983) [1981-1984 Transfer Binder] Cal.Tax Rptr. (CCH) H 400-383, p. 22,561 (Standard Oil); Appeal of DPF, Inc. (Oct. 28, 1980) [1978-1981 Transfer Binder] Cal.Tax Rptr. (CCH) H 206-429, p. 14,965-36; Kroehler, supra, [1971-1978 Transfer Binder] Cal.Tax Rptr. (CCH) H 205-646, p. 14.897- 122; Appeal of New York Football Giants, Inc. (Feb. 3, 1977) [1971-1978 Transfer Binder] Cal.Tax Rptr. (CCH) 205-600, p. 14,897-31 (New York Football Giants).)
Only Alabama has not amended its definition 'of business income to include a functional test. Of course, the Alabama Supreme Court only issued its decision rejecting the functional test in August 2000.
In describing the functional test in terms of the production of business income, we mean the production of income that unquestionably fits within the statutory definition of business income.
Dissenting Opinion
I respectfully dissent.
The Uniform Division of Income for Tax Purposes Act (Rev. & Tax. Code, § 25120 et seq.) (UDITPA) was intended to help the several states avoid laying conflicting claims on the income of multistate businesses, thereby facilitating compliance with the due process and commerce clauses of the United States Constitution. In today’s decision, the court encourages conflicting claims by defining as allocable “business income” (Rev. & Tax. Code, § 25120, subd. (a)) precisely the same type of income that the highest court of a sister state in the only other decision directly on point has defined as nonallocable “nonbusiness income” (id., subd. (d); Union Carbide Corp. v. Offerman (2000)
I suspect the act will fail to a large degree, because the majority’s definition of business income is potentially all-encompassing. What the majority calls the transactional test captures income from
The majority’s broad definition of business income under the functional test has two problems, both of which strike at the heart of the UDITPA’s purpose of fostering the uniform, constitutional allocation of a single taxpayer’s income among the various states entitled to claim a portion thereof.
The first problem is that the majority’s definition of business income under the functional test potentially reaches all income from business-owned property, thereby rendering illusory, or nearly illusory, the category of nonallocable “nonbusiness” income recognized in the UDITPA. (Rev. & Tax. Code, § 25120, subd. (d).) The majority permits the casual reader to assume that some corporate investments, even after today’s far-reaching decision, may not be sufficiently integral to the corporation’s business operations for their sale to generate allocable business income. (See maj. opn., ante, at pp. 534-535.) The assumption seems to make the decision less far-reaching and therefore more palatable. But the courts and administrative agencies that wrote the opinions the majority cites for reassurance on this point did not have the benefit of today’s decision. After today’s decision, income from property is allocable business income if there is “an organic unity between the taxpayer’s property and business activities whereby the property contributes materially to the taxpayer’s production of business income.” (Maj. opn., ante, at p. 530.) If this test captures income from an ERISA trust, which a corporation does not own and in which the corporation has only a contingent, reversionary interest, then the test must also capture income from other investments in property owned by the corporation and expected at some point to produce income available for business activities. Because a corporation must be able to draw upon its assets for business purposes as and when necessary, the wise management of cash and surplus assets to achieve an appropriate balance of liquidity, risk and return is just as essential to the production of business income as the wise management of human resources. We can, therefore, be sure the State Board of Equalization will soon ask itself whether income from the cash management accounts and other investments, wherever located, of corporations doing some business in California is not subject to taxation in California on the same basis as reversionary income from an ERISA trust. While the majority correctly observes that the former type of income has not been taxed by nondomiciliary states as allocable business income in the past (see maj. opn., ante, at pp. 534-535), the majority’s decision offers no principled basis for predicting that such income will not be taxed as business income in the future.
The second problem is that the majority’s definition betrays a narrow, parochial
That said, I nevertheless agree with the majority that it may be “equitable” (maj. opn., ante, at p. 536) for California to tax the reversion to the extent Hoechst Celanese Corporation has deducted its contributions to the pension plan on its prior California tax returns. But equity in this sense is not a concern of the UDITPA. It is, instead, the domain of the tax benefit rule, a judicially developed principle that cancels out an earlier deduction when careful examination shows that a later event is fundamentally inconsistent with the premise on which the deduction was initially based. (Hillsboro National Bank v. Commissioner (1983)