United States: Oregon Supreme Court Finds Goodwill Proceeds Excludable From Sales Factor

The Oregon Supreme Court has affirmed an Oregon Tax Court decision holding that a taxpayer's gross receipts from the sale of goodwill should be excluded from the sales factor used to compute its Oregon corporate excise (income) tax liability.¹ In doing so, the Court clarified that for purposes of Oregon sales factor apportionment, an Oregon statute specifically excludes gross receipts from the sale of "intangible assets" (of which goodwill is classified) unless those gross receipts are derived from the taxpayer's primary business activity.² The Court rejected the Tax Court's conclusion that "intangible assets" means only "liquid assets," and held that the term carries its ordinary meaning.

Background

The taxpayer, a developer and seller of test, measurement and monitoring equipment, sold all of the assets of its printer division in 1999 to another corporation for approximately $925 million. Of that total sale price, roughly $590 million represented the gross proceeds from intangible assets, which were comprised of seven different types of intangible assets, generally referred to in total as "goodwill." On its originally filed Oregon corporation income tax return for that year, the taxpayer excluded the $590 million from the calculation of its sales factor. If included, the amount would have significantly increased the taxpayer's Oregon corporation income tax liability.

For the 2002 tax year, the taxpayer filed state and federal tax returns and reported a net capital loss. For federal income tax purposes, the taxpayer sought to carry back and apply that loss to its 1999 federal income tax obligation. In 2005, the Internal Revenue Service (IRS) issued a federal audit Revenue Agent's Report (RAR), which adjusted the amount of the original 2002 tax year loss. At that time, the taxpayer filed an amended 1999 Oregon corporation income tax return and claimed a net capital loss carryback based on the reduced net capital loss reflected in the 2005 RAR. The taxpayer applied the loss against its original 1999 Oregon tax obligation.

After receiving the amended return, the Oregon Department of Revenue permitted the taxpayer to apply the net capital loss carryback against its 1999 tax liability, but also recomputed the taxpayer's Oregon tax liability including the proceeds from the sale of goodwill in the computation of the taxpayer's sales factor for apportionment purposes, thus resulting in a tax assessment of $3.3 million.

The taxpayer challenged this assessment in the Oregon Tax Court on the basis that the Oregon statute of limitations prevented the Department from assessing additional tax based on the change in the sales factor. The Tax Court granted the taxpayer's motion and denied a cross-motion from the Department claiming that the statute of limitations had restarted because of the issuance of the 2005 RAR. The parties then entered into a settlement agreement which allowed the Department to appeal the statute of limitations and sales factor issues.

Oregon Supreme Court Affirms Summary Judgment

In affirming the Tax Court's decision, the Oregon Supreme Court never reached the issue of whether the statute of limitations prevented the Department from imposing additional tax as a result of the sales factor issue. Rather, the Supreme Court concentrated on the substantive issue regarding how to apportion business income under Oregon's version of the Uniform Division of Income for Tax Purposes Act (UDITPA).³ The determination of whether allocation or apportionment is appropriate generally is based on the UDITPA definitions of "business income" and "nonbusiness income."⁴ Oregon statutes define business income 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, the management, use or rental, and the disposition of the property constitute integral parts of the taxpayer's regular trade or business."⁵ For the tax year at issue, business income was apportioned to Oregon via a formula consisting of a property factor, a payroll factor and a double-weighted sales factor.⁶

At issue in this case was whether the proceeds from the sale of intangibles should be included in the computation of the Oregon sales factor.⁷ The term "sales" includes all gross receipts of the taxpayer not subject to allocation as nonbusiness income.⁸ In addition, the statutory definition of "sales": (i) excludes gross receipts arising from the sale, exchange, redemption or holding of intangible assets, including but not limited to securities, unless those receipts are derived from the taxpayer's primary business activity; (ii) includes net gain from the sale, exchange or redemption of intangible assets not derived from the primary business activity of the taxpayer but included in the taxpayer's business income; and (iii) excludes gross receipts arising from an incidental or occasional sale of a fixed asset or assets used in the regular course of the taxpayer's trade or business if a substantial amount of the gross receipts of the taxpayer arise from an incidental or occasional sale or sales of fixed assets used in the regular course of the taxpayer's trade or business.⁹

Specifically, the Supreme Court focused on whether the gross proceeds from the intangible assets sold constituted "sales" for purposes of determining the Oregon sales factor. The Department argued that since the printer division was central to the taxpayer's primary business activity, the proceeds from such division should be characterized as receipts derived from the taxpayer's primary business activity includable in the sales factor calculation.¹⁰ In its analysis, the Supreme Court focused on the applicable statute and related definition of "intangible assets,"¹¹ noting the narrow meaning of that term identified by the Tax Court. Though the Supreme Court considered the Department's position, which was reliant upon: (i) legislative history; (ii) a model regulation adopted by the Multistate Tax Commission; and (iii) other 1999 legislative testimony, it ultimately determined that the term "intangible assets" as used in Or. Rev. Stat. Section 314.665(6)(a) is not limited to include only liquid assets.

Thus, the Supreme Court concluded that the $590 million received by the taxpayer as gross proceeds from the sale of intangible assets met this statutory definition, so those receipts must be excluded from the sales factor unless the receipts were derived from the taxpayer's primary business activity. Despite the fact that the printer division was central to the taxpayer's primary business of manufacturing and distributing electronic products, the sale of that division itself was not the taxpayer's business activity. No evidence was presented by the Department to support its assertion that the taxpayer's primary business was engaging in the sale of its divisions. The Court determined that the $590 million was required to be excluded from the sales factor as those receipts were derived from the sale of intangible assets which were not from the taxpayer's primary business activity.

The Supreme Court's analysis contrasted with that of the Tax Court, which had determined that the term "intangible assets" was generally intended to include only liquid assets associated with a taxpayer's treasury function. Specifically focusing its attention on the legislative record surrounding the adoption of Or. Rev. Stat. Section 314.665(6), the Tax Court noted that there was no indication that the legislation went beyond the treatment of treasury function receipts or addressed the receipts from all sales of intangible property. Concluding that neither Or. Rev. Stat. Section 314.665(6)(a) nor (6)(b) could be a basis for including some or all of the receipts from the taxpayer's disposition of goodwill in the computation of the sales factor, the Tax Court looked to regulatory guidance governing how to treat proceeds from sales of intangible property for sales factor purposes.

In concluding that that proceeds from the sale of goodwill was excludible, the Tax Court focused on a Department regulation providing that if business income from an intangible asset cannot readily be attributed to a particular business activity of the taxpayer, the proceeds from the sale of that intangible asset must be excluded from the calculation of the sales factor, to exclude the proceeds from the sale of goodwill from the taxpayer's sales factor computation.¹² In its decision, the Tax Court noted that "the goodwill at issue here is a composite of all of the business activities of a taxpayer over time and in all locations where the business of the taxpayer is carried on. . . . That being the case, it is the conclusion of the court that the amount paid by the purchaser to taxpayer in this case cannot 'readily' be attributed to any particular income producing activity."¹³

Commentary

This case is interesting in that it specifically focuses on the treatment of proceeds from the sale of goodwill for sales factor purposes. Despite the substantial sums often attributed to goodwill in sales transactions, little specific guidance exists with respect to the treatment of related proceeds for sales factor purposes. Although many states provide rules and limited guidance regarding the treatment of proceeds from sales of intangible assets in general, most do not specifically address goodwill. Presumably, since many states, like Oregon, rely on statutory language similar to that suggested by UDITPA and source proceeds from readily identifiable income producing activities based on the location of the related activity or where its benefit is received, the results here have potential wide-reaching effect.

Besides the specific treatment of goodwill proceeds, the following ancillary issues are evident from the case:

1. Though this case specifically deals with the treatment of gross proceeds from the sale of goodwill, it is possible that the conclusion could apply to proceeds from sales of other intangible assets as well, especially since relevant statutory language does not typically distinguish between goodwill and other intangible assets. For example, proceeds from the sale of patents, copyrights and other intangible assets could also potentially be excluded from the sales factor computation based on similar reasoning.
2. It is notable that since the relevant time period in this case, some changes have occurred which could have potentially changed its outcome. For example, an administrative rule that has since been promulgated in Oregon now lists seven specific criteria used to determine a taxpayer's primary business activity.¹⁴ Had this rule been in existence for the tax period in issue, certainly the Court would have focused much more attention on whether the proceeds from the sale of goodwill were derived from the taxpayer's primary business activity and were, therefore, necessarily includable in the taxpayer's sales factor computation.
3. The statutory exclusion from the sales factor computation for a substantial amount of gross receipts from an incidental or occasional sale in Oregon applies specifically to fixed assets used in the regular course of the taxpayer's trade or business. Though the taxpayer asserted at the Tax Court level that its goodwill was a fixed asset, the Tax Court never reached the merits of this argument, and it is entirely conceivable that the term "fixed" could be construed to require that the asset is tangible in nature. Even so, it would be interesting to see what conclusions other courts might reach based on this reasoning.
4. Though the taxpayer in this instance did not assert that the proceeds from the sale of its goodwill were allocable nonbusiness income, it is not difficult to imagine a taxpayer with a similar fact pattern making such assertion. This argument would have led to a very different analysis by the Court and potentially a different conclusion.
5. The discussions by both the Tax Court and the Supreme Court in this instance provide detailed commentary regarding whether intangibles include more than simply liquid assets. Potential implications of including goodwill and other "non-liquid" assets in this category could include both property tax and sales tax issues, depending on particular definitions and their applicability in various jurisdictions.

With the increased level of corporate transaction activity over the past several years, corporations receiving proceeds from the sale of goodwill should carefully analyze this decision and consider whether it could have any potential impact on their state income tax liability or tax provision.

Footnotes

1 Tektronix, Inc. v. Department of Revenue, Oregon Supreme Court, No. SC S060912, Dec. 12, 2013.

2 OR. REV. STAT. § 314.665(6)(a).

3 OR. REV. STAT. §§ 314.605-314.675.

4 See Crystal Communications, Inc. v. Department of Revenue, 297 P.3d 1256 (Or. 2013). Under UDITPA, whether income is allocated or apportioned depends on whether that income is classified under the statute as "business income" or "nonbusiness income."

5 OR. REV. STAT. § 314.610(1).

6 OR. REV. STAT. § 314.650(1). The current version of the statute no longer includes the property or payroll factors. Instead, apportionment is based solely upon the sales factor.

7 The Oregon sales factor is a fraction, the numerator of which is the taxpayer's total sales in Oregon during the tax period, while the denominator is the taxpayer's total sales everywhere during the tax period. OR. REV. STAT. § 314.665(1).

8 OR. REV. STAT. § 314.610(7).

9 OR. REV. STAT. § 314.665(6)(a)-(c).

10 After a review of the legislative history surrounding the enactment of OR. REV. STAT. § 314.665(6)(a), the Tax Court had determined that the exclusion of "intangible assets" found in the statute referred only to "liquid assets" (i.e., those assets held to provide a relatively immediate source of funds to satisfy the liquidity needs of the trade or business). Tektronix, Inc. v. Department of Revenue, Oregon Tax Court, No. TC 4951, June 5, 2012.

11 "Intangible asset" broadly means "any nonphysical asset or resource that can be amortized or converted to cash, such as patents, goodwill, and computer programs, or a right to something, such as services paid for in advance." Black's Law Dictionary 134 (9th ed. 2009).

12 OR. ADMIN. R.150-314.665(4)(3).

13 Tektronix, Inc. v. Department of Revenue, Oregon Tax Court, No. TC 4951, June 5, 2012.

14 OR. ADMIN. R.150-314.665(6)(3), effective Dec. 31, 2000.

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