United States

California: Court of Appeal Affirms Decision on Unitary Relationship and Characterization of Merger Termination Fee as Business Income

Dec 19, 2016
From KPMG TaxWatch

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In a lengthy unpublished opinion, the California Court of Appeal affirmed in full a trial court ruling that (1) a cable company taxpayer and a home shopping channel subsidiary were not engaged in a unitary business, and (2) a fee received by the taxpayer after a failed merger constituted apportionable business income. In addressing whether the cable company and the home shopping channel in which it owned a majority interest were engaged in a unitary business, the trial court, relying primarily on testimony from executives of both companies, determined that after the taxpayer acquired a majority interest in the home shopping channel, it had the ability to exert management influence and control over the channel. However, the evidence established that the companies continued to operate independently of each other. The taxpayer did not exert control over the channel and did not change any of its operations. Likewise, the trial court held a carriage agreement between the taxpayer and the channel (in which the shopping channel paid the taxpayer a commission of five percent on sales to the taxpayer’s subscribers) reflected the same arm's length market terms the channel offered every other major cable and satellite distributor. Based on these findings, the appeals court held that the trial court correctly concluded that the shopping channel and the taxpayer were not engaged in a unitary business. Although commonly owned, the entities were not integrated in a way that transferred value between them.1

The appeals court next addressed whether a termination fee received by the taxpayer following a failed merger was apportionable business income. The trial court had concluded that the termination fee constituted business income under both the transactional and functional tests. On appeal, the taxpayer argued that in applying the transactional test, the trial court improperly focused on the asset that gave rise to the income―the cable company acquisition agreement―rather than the transaction that generated the income―the termination of the merger agreement. Although the taxpayer regularly entered into similar agreements in the course of its business, the failed merger was an extraordinary event and therefore, relying on the Hoechst Celanese decision, the taxpayer argued that the transactional test was not met. The appeals court rejected this position. It its view, the merger agreement was the activity that gave rise to the income at issue, not the subsequent failure of the merger that triggered the payment. Because the taxpayer regularly entered into acquisition agreements, the income at issue was business income under the transactional test. The taxpayer also challenged the Board’s calculation of its sales factor for the year at issue. Specifically, the Board had included the termination fee in the tax base, but not in the sales factor denominator. This lack of factor representation, the taxpayer argued, was improper because the Board had not established that the standard apportionment provisions did not represent the taxpayer’s in-state activity. The appeals court rejected this argument, holding that the taxpayer had forfeited its ability to challenge the Board’s calculation of its sales factor for by not raising the issue in its refund claims or complaint. For more information about Comcon Prod. Servs. I. Inc. v. Cal. Franchise Tax Bd., please contact Scot Grierson at 949-885-5643.


1 In making its determination, the appellate court found that the various tests sometimes employed to determine unity (including the Mobil Oil tests of centralized management, functional integration and economies of scale, the “three unities tests of Butler Brothers (unity of ownership, operation and use) and the “contribution and dependency test of Edison California Stores) were “closely related” and the trial court did not err in misunderstanding the essential test and did not misapply the appropriate legal principles.



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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.