Union Carbide Corp. v. Offerman

LEWIS, Judge. Pursuant to the Supreme Court’s order we have reconsidered the issues presented, and we affirm our prior decision. Plaintiff Union Carbide Corporation is a New York corporation domiciled in Connecticut and qualified to do business in North Carolina. Its principal business is the manufacture and sale of chemical products. Fearing a hostile takeover after a 1984 chemical gas leak in Bhopal, India, Union Carbide adopted a restructuring plan designed to increase stock prices. In 1985, Union Carbide’s defined benefit pension plan trust held more assets than legally necessary to provide benefits to Union Carbide employees; it was substantially overfunded because of better than expected investment returns. Although Union Carbide had some input in investment decisions, it did not own or manage the pension plan trust, and individual employees were the beneficiaries of the plan. As part of the corporate restructuring, Union Carbide effected a reversion of pension plan funds from the overfunded pension plan. Federal law permits such reversions under certain circumstances, and Union Carbide sought and received permission to effect a reversion of the excess funds by removing part of the pension trust’s assets and creating a trust for a new plan. Union Carbide used the removed assets to purchase annuities to pay for employee benefits. The excess funds after the annuity purchase ($500 million) were used to buy the company’s stock. Union Carbide thus used a reversion from the overfunded pension plan to avoid a hostile takeover. Union Carbide classified the $500 million as nonbusiness income under N.C. Gen. Stat. § 105-130.4(a)(l) (1985) and allocated the entire amount to Connecticut for taxation there. The state of North Carolina [667] reclassified the reversionary income as business income and levied tax on the $500 million. Union Carbide brought this action under N.C. Gen. Stat. § 105-267 (1986), seeking a refund of taxes paid. In our first decision, we addressed three issues: whether the reversion was business income to Union Carbide, whether Union Carbide made timely protest, and whether interest was properly awarded. The latter two parts of our decision are unaffected by the recent Polaroid II decision, and we decline to revisit them in the absence of a mandate to do so. Accordingly, the lone issue we decide is whether the pension plan reversion income is properly classified as business income or non-business income under the two-prong test of Polaroid II. We hold that the reversionary income is nonbusiness income, and we affirm our prior decision. The statutory definition of business income has not changed since 1985. Business income is income arising from transactions and activity in the regular course of the corporation’s trade or business and includes income from tangible and intangible property if the acquisition, management, and/or disposition of the property constitute integral parts of the corporation’s regular trade or business operations. N.C. Gen. Stat. § 105-130.4 (a)(1) (1997). Nonbusiness income is “all income other than business income.” N.C. Gen. Stat. § 105-130.4(a)(5) (1997). Our previous Union Carbide decision was based squarely on our decision in Polaroid Corp. v. Offerman, 128 N.C. App. 422, 496 S.E.2d 399 (Polaroid I), rev’d, 349 N.C. 290, 507 S.E.2d 284 (Polaroid II) (1998), and as such we applied only the transactional test in determining that the reversion was non-business income. Pursuant to Polaroid II, however, we must consider two tests for business income — the transactional test and the functional test — in determining if the reversion is business income. See Polaroid II, 349 N.C. at 301, 507 S.E.2d at 293. The first clause of the definition of business income creates the transactional test. See Polaroid II, 349 N.C. 295, 507 S.E.2d at 289. Three aspects of the income must be considered under this test: “the frequency and regularity of similar transactions, the former practices of the business, and the taxpayer’s subsequent use of the income.” Id. The main inquiry “revolves around the nature of the particular transaction giving rise to the income.” Id. (emphasis added). In our previous Union Carbide opinion, we determined that the reversion of [668] excess pension funds, rather than the operation of the pension plan itself, was the transaction that created income. The removal of funds from an overfunded pension plan by Union Carbide was a rare and extraordinary event; the evidence indicates no such removal occurred before or since the reversion at issue. As such, the reversion to Union Carbide did not occur in the “regular course of the corporation’s trade or business.” N.C. Gen. Stat. § 105-130.4 (a)(1). The reversion is not business income under the transactional test. We now áddress for the first time whether the monies received from the reversion of pension plan funds constitute business income under the second clause of the definition, the functional test. Polaroid II directs that the definition of business income is to be read grammatically as follows: “[business income] includes income from tangible and intangible property if the acquisition, management, and/or disposition of the property constitute integral parts of the corporation’s regular trade or business operations.” Id. at 298, 507 S.E.2d at 290-91. Polaroid II explains the test in differing ways, however. First, “[u]nder the functional test, income is classified as business income if it arises from the acquisition, management, and/or disposition of an asset that was used by the taxpayer in the regular course of business.” Polaroid II at 296, 507 S.E.2d at 289 (emphasis added). Later, we see another phrasing, directing us that “reading the second clause as a whole, business income includes income obtained from acquiring, managing, and/or disposing of property which is essential to the corporation’s business operation." Id. at 301, 507 S.E.2d at 292-93 (emphasis added). We believe that the second version, which follows more closely the terms of our statute, is the true directive intended by the Supreme Court, and we will apply that interpretation. Under the functional test, the extraordinary or infrequent nature of the event is irrelevant. Id. at 296, 507 S.E.2d at 289. The relevant inquiry addresses the character of the property that generated the income; extraordinary transactions may generate business income if the relevant asset was an integral part of the corporation’s regular trade or business. Id. at 296, 507 S.E.2d at 289-90. Polaroid II further explains the functional test and says that “the phrase ‘acquisition, management, and/or disposition’ contemplates the indicia of owning corporate property.” Id. at 301, 507 S.E.2d at 292. Moreover, “integral” means “essential to completeness.” Id. Therefore, we discern three important inquiries in determining if income is business income under the functional test as set forth in Polaroid II: (1) whether there [669] are indicia of corporate ownership of the property; and (2) whether the property is “essential to completeness” of the (3) regular trade or business. Id. at 301, 507 S.E.2d at 292-93. The State asserts that Polaroid II, in finding that the patent infringement suit proceeds were business income, is dispositive of this case. We disagree. In Polaroid I and Polaroid II, there was no dispute about the ownership or the integral nature of the patents. Indeed, Polaroid’s primary source of income was sale of products on which the corporation owned patents. As such, Polaroid owned the property at issue, and the patents were integral to the regular course of Polaroid’s business. Each of the three factors above was satisfied, and the income was found to be business income under the functional test. Here, however, Union Carbide did not own any interest in the pension plan trust. Union Carbide’s only role was a legally created one of fiduciary; the trust was held and managed by a trustee and the beneficiaries were individual employees and retirees. Furthermore, there is no evidence that the pension plan was or is essential to Union Carbide’s chemical business. It was not legally mandated; its creation by Union Carbide was voluntary. A pension may be an attractive aspect of a compensation package, but it is not indispensable to operating a profitable chemical business. And, unlike Polaroid which relied on its patents to create income in its regular course of business, Union Carbide does not rely on its employees’ pension plan to create corporate income. Therefore, we hold that there is no evidence that Union Carbide’s pension plan was essential to its regular course of manufacturing and selling chemicals. As such, any income derived from the management, acquisition, or disposition of it is nonbusiness income to Union Carbide under the functional test. Since the income also is nonbusiness income under the transactional test, we affirm our prior decision in full. Affirmed. Judge GREENE concurs. Judge HORTON dissents.