NONBUSINESS INCOME
§ 170.1. Nonbusiness income—liquidations; effect of Laurel Pipe Linedecision.
(a) The significant factual elements involved in Laurel Pipe Line Co. v. Board of Fin. & Revenue, 642 A.2d 472 (Pa. 1994) are as follows:
(1) The pipeline operation in issue had been discontinued and was idle for at least 3 years.
(2) The remaining pipeline operation of the company was independent from the pipeline operation that was sold, including a distinctive geographical separation.
(3) No proceeds of the sale were used to acquire any assets for future use in the business, nor were any reinvested back into the operations of the business.
(4) No proceeds of the sale were used to generate income for future use in the business operations, nor were any invested in financial securities that would generate income for the company.
(5) The entire after-tax net proceeds from the sale were distributed to the shareholders in the form of a dividend.
(b) The law applied in the case is the so called ‘‘functional test,’’ which is derived from the second clause of the statutory definition of ‘‘business income:’’ ‘‘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.’’ 72 P. S. § 7401(3)2.(a)(1)(A). The Supreme Court has interpreted the Commonwealth Court’s opinion in Welded Tube Co. v. Commonwealth, 101 Pa. Cmwlth. 32, 515 A.2d 988 (1986) as holding that under the functional test ‘‘income meets the functional test if the gain arises from the sale of an asset which produced business income while it was owned by the taxpayer.’’ Laurel, 642 A.2d at 475.
(c) The Supreme Court in Laurel notes that in Welded Tube the taxpayer had a regular practice of acquiring property in the expansion of its business and reinvesting any gains in its ongoing business. In contrast, Laurel engaged in what the Supreme Court describes as a ‘‘singular disposition’’ of property.
(d) In finding that the disposition at issue in Laurel was not an integral part of Laurel’s business, the Supreme Court focuses on the following facts:
(1) The ‘‘singular’’ nature of the disposition.
(2) The pipeline was idle for 3 years.
(3) The disposition was not made in the course of acquiring new assets.
(4) This was a liquidation as evidenced by a lack of reinvestment of the proceeds in the business—no assets were acquired and no proceeds were used to generate income or invested in financial securities that would generate income for the company—and the entire net proceeds were distributed to the shareholders.
(5) The pipeline disposed of was a separate and distinct ‘‘aspect’’ of Laurel’s business, and the remaining pipeline was independent from the sold pipeline.
(6) Laurel divested itself of this ‘‘aspect’’ of its business and the structure of its business has changed as a result.
(e) That no one fact alone controlled the result in Laurel is evident by the Court’s statement that ‘‘the totality of the circumstances surrounding the sale of the . . . pipeline has persuaded us that the transaction is one that can be characterized as a partial liquidation which has changed the structure of the taxpayer’s business.’’ 642 A.2d at 477. By citing the Welded Tube decision without apparent disagreement, the Supreme Court impliedly has approved that decision; but there are basic factual differences which dictated a contrary result in Laurel. These differences are:
(1) Laurel involved a partial liquidation while Welded Tube was a reorganization.
(2) In Laurel, a separate aspect of its business was sold while in Welded Tube only a part of the company’s business was sold.
(3) Laurel returned the proceeds to its shareholders while Welded Tube reinvested its proceeds.
(4) Laurel’s business structure changed while Welded Tube’s did not.
(f) Unlike Welded Tube, Laurel deals with the liquidation of a distinct aspect of the taxpayer’s business, which aspect ceases following the liquidation.
(g) The policy implications are as follows:
(1) Laurel’s interpretation of Welded Tube’s statement of the functional test—that is, ‘‘Income meets the functional test if the gain arises from the sale of an asset which produced business income while it was owned by the taxpayer,’’—is clarified with respect to liquidations by the decision in Laurel. 462 A.2d at 475. A liquidation to which the Laurel decision applies is a liquidation where a separate and distinct aspect of the taxpayer’s business ceases and the proceeds are returned to the shareholders. Such an aspect of the taxpayer’s business may be comprised of assests once used in the taxpayer’s regular trade or business operations if there is evidence that the assets no longer comprise a part of the operations.
(2) It is the policy of the Department that any disposition of assets for which nonbusiness income is claimed pursuant to a liquidation must have been removed from the relevant apportionment factors prior to the disposition for a period of time consistent with the facts of the individual case. In addition, the taxpayer is required to show by clear and convincing evidence that for the period the assets were not a part of its regular trade or business operations. The proceeds from such a disposition shall be distributed to the shareholders of the corporation and may not be used to acquire assets for future use in business operations or to generate income for use in future business operations.
Source The provisions of this § 170.1 adopted November 11, 1994, effective November 12, 1994, 24 Pa.B. 5659.
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