PA Supreme Court Issues Business / Nonbusiness Income Decision

by McNees Wallace & Nurick LLC


The Pennsylvania Supreme Court has held that a taxpayer’s gain from the sale of timberland was apportionable business income using the “functional test” of Pennsylvania’s amended definition of “business income.” Glatfelter Pulpwood Co. v. Commonwealth, No. 62 MAP 2011 (Pa. January 22, 2013). The Court has substantially limited the continuing viability of its prior holding in Laurel Pipe Line v. Bd. of Fin. & Rev., 642 A.2d 472 (Pa. 1994), which treated the liquidation of a separate and distinct aspect of a business as “nonbusiness income.”


Glatfelter’s sole business activity was to obtain pulpwood for its parent company’s paper manufacturing processes. The company grew and harvested timberland in Maryland, Delaware, Pennsylvania and Virginia. Sometime in 2003, a business decision was made to sell off approximately 5,000 acres of timberland holdings in Delaware. The company reported tax on 100% of the gain to Delaware.

On appeal, the Commonwealth Court agreed with the Pennsylvania Department of Revenue that 42% of the gain was apportionable to Pennsylvania as business income. The company appealed to the Pennsylvania Supreme Court.

Court’s Decision
On appeal, Glatfelter argued that the gain from the sale of the Delaware timberland was nonbusiness income because the sale was a partial liquidation of a separate and distinct line of the taxpayer’s business, relying on the holding in Laurel Pipe. Further, the company argued that the sale of the timberland was unrelated to its regular business operations in Pennsylvania. Finally, the company argued that Pennsylvania’s attempt to tax 42% of the gain from the sale of timberland in Delaware, when Delaware taxed 100% of it, violated the Due Process and Commerce Clauses of the United States Constitution.

The Court first addressed the business/nonbusiness issue. The Court reaffirmed that there are two separate and distinct tests for determining whether income is business income - the “transactional test” and the “functional test.” The Commonwealth Court had held that the sale of the timberland did not satisfy the “transactional test”; that is, the company did not engage in the sale of timberland in the regular course of its business. The Commonwealth Court, however, did find that the “functional test” of business income was met, and that was the test the Supreme Court focused on.

With respect to the functional test, the Court recognized that prior to 2001, Pennsylvania defined “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, 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), repealed and revised in 2001 (emphasis added). In 2001, the definition of “business income” was amended to read:

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 either the acquisition, management or disposition of the property constitutes integral parts of the taxpayer’s regular trade or business operations.

72 P.S. § 7401(3)2.(a)(1)(A)(emphasis added).

The Court viewed this statutory amendment changing the text from conjunctive, “and”, to disjunctive, “or”, as a basis for distinguishing Glatfelter’s case from Laurel Pipe.

In Laurel Pipe, decided under the pre-amendment statute, the Court found that disposition of a pipeline was nonbusiness income. Under the pre-amendment statutory definition the acquisition, management, and disposition of property had to constitute an integral part of the taxpayer’s business for a gain to be business income. This holding effectively created a “liquidation exception” to business income. After Laurel Pipe, however, the statute was amended as set forth above.

Now, the Court’s holding in Glatfelter has made clear that if gains from either the acquisition or management or disposition of property constitutes an integral part of the taxpayer’s business, the gain will be characterized as business income. In Glatfelter, the record was clear that the acquisition and management of the timberland were integral parts of the taxpayer’s business. Therefore, the gain from the sale was business income. The Court noted that its holding was based “largely on the amendments to the relevant statutory definition of business income since Laurel Pipe was decided.”

Interestingly, the Court, while recognizing that the General Assembly’s intent of the 2001 amendment to the definition of “business income” was to “clarify existing law,” 72 P.S. § 7401 (Historical and Statutory Notes (quoting Act 2001-23 § 25), did not discuss what that meant. Instead, the Court adopted the view that the 2001 amendments substantially changed the definition from conjunctive to disjunctive.

Next, the Court addressed Glatfelter’s alternative argument that the disposition of the timberland was so unrelated to the taxpayer’s Pennsylvania business activities that it should not be subject to Pennsylvania’s corporate net income tax. The Court soundly rejected that argument, reasoning that the sale of the timberland was integrally related to the taxpayer’s business activities in Pennsylvania, and that the timberland was not relegated to an “unrelated asset” just because a decision was made to sell it.

Finally, the Court also rejected the company’s arguments regarding the Due Process and Commerce Clauses - that the application of the apportionment formula to the timberland gain was improper because there was no rational relationship between the sale and taxpayer’s business activities, and that the income attributed to Pennsylvania was out of proportion to the business the company conducts in Pennsylvania. The Court held that the taxpayer is a unitary business, operating as an integrated whole with its sole purpose to deliver pulpwood to its parent company. Therefore, the Court reseasoned, the taxpayer is properly subject to Pennsylvania’s corporate net income tax. The Court also rejected the “double taxation” argument by citing United States Supreme Court precedent that double taxation does not necessarily make a fairly apportioned tax unconstitutional.

In the wake of the Glatfelter decision, it will be necessary for taxpayers who liquidate a line of business and seek nonbusiness income treatment to show that neither the acquisition, nor the management nor the disposition of the property giving rise to the gain was an integral part of its business. Obviously, the “liquidation” exception to business income in Pennsylvania has been severely weakened.

If you have any questions about the Glatfelter decision, or if your business has a possible business/nonbusiness income issue, please contact a member of the McNees SALT team.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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