United States

Indiana: Income from Forced Operating Division Sale Nonbusiness Income

Jan 12, 2015
From KPMG TaxWatch

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In a recent Indiana Letter of Findings, the Department of Revenue held that a taxpayer’s income from the forced sale of two divisions was nonbusiness income. The taxpayer at issue entered into an agreement to purchase all the stock of one of its competitors. The taxpayer requested guidance from the Federal Trade Commission prior to entering into the transaction. The Federal Trade Commission determined that the taxpayer could not acquire two of the competitor’s divisions, because it would then have an unfair monopoly in the relevant markets. Thus, the taxpayer, despite its wishes, was prohibited from acquiring these divisions. Subsequently, an unrelated corporation agreed to purchase the assets of the two divisions after which it would become the taxpayer’s direct competitor. This solution was blessed by the Commission. The Acquired Corporation sold off its divisions as planned and reported the gain on its 2006 return as nonbusiness income. This increased the Acquired Corporation’s NOLs for the tax year, which were later used by the taxpayer as successor in interest to the corporation’s tax attributes. On audit, the Department asserted that the Acquired Corporation should have treated the gain from the division sale as business income. This adjustment reduced the taxpayer’s NOLs available for carryover, which the taxpayer protested.

Under Indiana law, business income is defined as "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 constitutes integral parts of the taxpayer's regular trade or business operations." This definition encompasses two tests. If either test is met, the income is business income.  The transactional test looks at whether the "income arises from transactions and activity in the regular course of the taxpayer's trade or business.” The Department agreed that the income at issue was not from transactions regularly undertaken by the taxpayer. Analyzing whether the income was business income under the second, functional test, the Department noted that in an earlier Indiana court case, the court held that the “functional test” requires that the disposition of an asset be an integral (defined as necessary or essential) part of the taxpayer’s regular business operations. In that case, the taxpayer’s sale was also executed pursuant to an anti-trust court order and actually benefited a third-party. The court concluded that the sale was not a necessary and essential part of the taxpayer’s business, the functional test was not satisfied and the proceeds were nonbusiness income. Likewise, in the instant case, the taxpayer at issue wished to purchase the Acquired Corporation’s divisions but was prohibited by to the Federal Trade Commission. The sale of the divisions did not benefit the taxpayer, but benefited the new third party competitor. As such, the sale was not a necessary and essential part of the taxpayer’s business. Accordingly, Department rejected the auditor’s conclusion that the income at issue was business income. Please contact Marc Caito at 317-951-2434 with questions on this Letter of Findings # 02-201403306.

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The following information is not intended to be "written advice concerning one or more federal tax matters" subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.