United States

Oregon: Tax Court Holds that Stock Served an Operational Function in Taxpayer’s Business

May 04, 2015
From KPMG TaxWatch

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Recently, the Oregon Tax Court addressed whether Oregon could tax an apportioned share of gain from the sale of stock held by an out-of-state taxpayer. Specifically, the issue before the court was whether the stock served an operational, as opposed to investment, function in the taxpayer’s unitary business, a part of which operated in Oregon, so that taxation of the gain was permissible under the Commerce Clause.

The taxpayer owned and operated radio and television stations in various Western states, and was admittedly engaged in a unitary business with the several affiliates.  During the relevant tax years the taxpayer held stock, acquired in 1923, in Safeco—a Washington-based property and casualty insurance company. The taxpayer’s investment represented 2.2 percent to 2.9 percent of Safeco’s total outstanding shares. The taxpayer entered into two different financing transactions involving the Safeco stock that were of interest to the court. The first was a “forward” transaction in which three million shares of the taxpayer’s Safeco stock were collateralized. The proceeds from the forward were used to repay debt, finance construction of corporate buildings, and for general corporate purposes. In the second transaction, the taxpayer completed the placement of $150 million of senior notes and a $20 million revolving credit facility (the “Notes and Revolver” transaction). The indenture for the notes and the credit agreement for the Revolver placed certain restrictions on the taxpayer’s use of the Safeco stock and the use of any proceeds from the taxpayer’s sale of the stock. The court termed this a negative pledge of the assets as opposed to an affirmative.

In late 2007 and the first half of 2008, as a result of Safeco merging with another company, the taxpayer sold its stock. The gain was used, in part, to acquire two new California television stations. Although the taxpayer had reported the Safeco dividends as business income on its originally-filed returns, it subsequently filed amended returns treating the dividends as nonbusiness income. Likewise, the gain from the Safeco stock sale was treated as nonbusiness income on the taxpayer’s 2007 and 2008 Oregon corporate excise returns. The Department protested the characterization of the gain as nonbusiness income and the matter went before the Oregon tax court.

The first issue before the court was whether the Safeco stock had a unitary relationship with the taxpayer’s multi-media business so that Oregon could tax an apportioned share of the gain. The second was whether the taxpayer was liable for penalties. With respect to the first issue, the court noted that a unitary relationship between an operating business and an intangible asset in a discrete business exists when the ownership of the asset serves an operational, rather than, investment function. The taxpayer’s business does not need to be unitary with the business or enterprise that is represented by the intangible asset (i.e., the stock). The Safeco stock, the court observed, could not be considered to have an operational function simply because it (1) increased the taxpayer’s general net worth or credit worthiness, (2) was acquired for a business purpose, (3) generated income that was commingled with general corporate funds, or (4) was held for future use or proceeds from its sale were deployed after the sale in the taxpayer’s business. However, courts have held that the pledge of an intangible asset to obtain financing for the taxpayer’s unitary business may serve an operational function. The taxpayer, the court observed, could not argue that the proceeds from its financing transactions involving the stock were not employed in its multi-media enterprise. As such, it was necessary to examine the substance of the financing transactions to determine if they involved the use of the Safeco stock in an operational function.  After reviewing both transactions, the court concluded that the stock served an operational function. The key transaction—the Notes and Revolver—placed significant restrictions on the taxpayer’s use of the Safeco stock, and the court found there was no constitutionally significant difference between the affirmative pledge of the assets and the negative pledge represented by the Notes and Revolver. The court thus concluded that the stock was an asset that, through the covenants in the indenture and the financing obtained through those covenants, was specifically devoted to and employed in the taxpayer’s unitary television and radio business.

The court next addressed whether the taxpayer had substantial authority for its position so that it was not liable for penalties. The court noted that while the taxpayer offered some cases that related to its position, it was clear the Safeco stock did not just sit idly on the taxpayer’s balance sheet serving a general corporate purpose. Rather, it was consistently and actively employed by taxpayer to obtain financing for its unitary business. As such, the court found the taxpayer did not have substantial authority for its positions and upheld the imposition of penalties. Please contact Rob Passmore at 503-820-6844 with questions on Fischer Broadcasting Co. v. Dep’t of Revenue.

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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.