Combustion Engineering, Inc., and Combined Subsidiaries v. Commissioner of Revenue (March 29, 2000)

COMMONWEALTH OF MASSACHUSETTS

APPELLATE TAX BOARD


COMBUSTION ENGINEERING,		v.		COMMISSIONER OF
INC., AND COMBINED 					REVENUE
SUBSIDIARIES			

Docket No. F228740					Promulgated:
								March 29, 2000


	This is an appeal under the formal procedure pursuant to G.L. c. 62C, § 39, from the refusal of the appellee to abate a corporate excise assessed against the appellant for the taxable period ending December 31, 1988.
	Chairman Gurge heard the appeal and was joined in the decision for the appellant by Commissioners Scharaffa, Burns, Gorton and Egan.
	These findings of fact and report are made pursuant to a request by the appellee under G.L. c. 58A, § 13 and 831 CMR 1.32.
	Jonathan M. Zorn, Esq. and Steven A. Kaufman, Esq., for the appellant.

	Kevin M. Daly, Esq., for the appellee.



FINDINGS OF FACT AND REPORT

	This appeal was submitted to the Appellate Tax Board ("Board") on an agreed statement of facts.  On the basis of the agreed statement, the Board made the following findings of fact.
	At all relevant times, Combustion Engineering, Inc. ("CEI") was a foreign corporation subject to the Massachusetts corporate excise.  Jamesbury Corporation was a subsidiary of CEI, acquired in 1984, actively engaged in business in the Commonwealth.  Jamesbury was a part of CEI's consolidated and combined return group up to the date its stock was sold, and participated in CEI's federal consolidated and Massachusetts combined returns.
	In September 1988, CEI sold its Jamesbury stock to Neles, Inc.  CEI and Neles elected under § 338(h)(10) of the Internal Revenue Code ("Code") to treat the sale for federal income tax purposes, as a sale of Jamesbury's assets.  Due to the election, Jamesbury recognized a gain on the "deemed sale" of its assets.  Correspondingly, CEI did not recognize gain when it sold the Jamesbury stock to Neles.
On October 18, 1989, CEI filed its Massachusetts combined return for 1988 that included Jamesbury's income for the short-year period preceding the sale to Neles.  Jamesbury's income subject to apportionment for the   short-year period included the gain on the deemed sale of Jamesbury's assets attributable to the § 338(h)(10) election.  CEI apportioned Jamesbury's income to Massachusetts for 1988 by including in the "sales factor" under G.L. c. 63, § 38, the amount of the deemed gain.  Subsequently, the Commissioner of Revenue ("Commissioner") assessed additional taxes by including in the "sales factor" the gross proceeds from Jamesbury's deemed sale of assets.  
CEI timely filed an application for abatement in which it claimed that no part of the proceeds from the subject transaction should be included in the sales factor.  The Commissioner denied the application for abatement and CEI timely filed its appeal with this Board.  Accordingly, the Board found that it had jurisdiction over this appeal.  
For the reasons explained in the following Opinion, the Board found that the gain realized on the § 338 deemed sale of Jamesbury's assets was properly included in Jamesbury's Massachusetts net income.  The Board further found that no portion of the gross proceeds or the gain realized from the sale of CEI's Jamesbury stock was includable in either the numerator or the denominator of Jamesbury's "sales factor" for the taxable year at issue under G.L. c. 63, § 38.  


OPINION

	The sole issue in the present appeal is whether in apportioning its net income subject to the Massachusetts corporate excise, Jamesbury was required to include in the "sales factor," the proceeds received from its deemed sale of assets.
	Every domestic and foreign corporation engaged in business in the Commonwealth is required to pay an excise based in part on its net income.  G.L. c. 63, § 39.  If two or more domestic or foreign corporations participate in the filing of a federal consolidated return, they may elect to compute their Massachusetts corporate excise based on their combined net incomes.  G.L. c. 63, § 32B.  The corporations' combined net income is ascertained by first separately determining the taxable net income of each corporation apportioned to this Commonwealth and then adding together each corporation's separately determined net income.  Id.
Computation of a corporation's Massachusetts net income generally starts with its federal gross income as defined under the Code, as in effect for the taxable year, with some exceptions not relevant to this appeal.  G.L.c. 63, § 30.  
For federal tax purposes, the parties to the subject transaction elected the treatment available under § 338 of the Code.  Section 338 provides, in pertinent part:
If a purchasing corporation makes an election under this section ... then, in the case of any qualified stock purchase, the target corporation-

Shall be treated as having sold all of its assets at the close of the acquisition date at fair market value in a single transaction, and

Shall be treated as a new corporation which purchased all of the assets ... at the beginning of the day after the acquisition date.  (Emphasis added).

I.R.C. § 338(a).  
The result of the election is twofold.  First, the target corporation, the corporation whose stock is being sold, recognizes a gain based on the difference between the basis of its assets and the assets' fair market value.  I.R.C. §§ 1001 and 1245.  This gain is then included in the target corporation's federal gross income.  Also, the target corporation gets a stepped-up basis in the assets.  I.R.C. § 338(b).  Second, if the target corporation and the corporation selling the stock are part of a consolidated group and the target corporation has recognized the gain, then the selling corporation does not recognize gain at the time the stock is sold.  I.R.C. § 338(h)(10)(A).
In the present appeal, CEI sold its Jamesbury stock to Neles and the parties made a § 338 election.  As a result, Jamesbury was treated as if it had sold its assets for fair market value.  The resulting gain was then included in its federal gross income and correspondingly its Massachusetts net income subject to apportionment.  Since CEI and Jamesbury were part of a consolidated group prior to the sale, there was no gain recognized by CEI when it sold the Jamesbury stock.  
After determining the corporations' net income, the next step is to determine the Massachusetts tax due pursuant to G.L. c. 63, § 38.  Where, as here, a corporation has income from business activity taxable both in Massachusetts and elsewhere, its taxable net income is apportioned to Massachusetts by means of a three-factor formula based on the ratio of its Massachusetts property, payroll and sales to its property, payroll and sales everywhere.  G.L. c. 63, § 38(c)-(f).  
For purposes of determining a corporation's sales factor, the statute defines the term "sales" as the "gross receipts of the corporation except ... gross receipts from the ... disposition of securities."(emphasis added).  G.L. c. 63, § 38(f).  Based on this definition of "sales," CEI argued that the proceeds generated from the sale of the Jamesbury stock were exempt from inclusion in the Massachusetts apportionment formula.  The Commissioner, however, argues that since CEI made a § 338 election to have the transaction treated as a sale of assets, that all proceeds from the sale were gross receipts includable in the "sales factor."
In support of its position, the Commissioner relies on the fact that Massachusetts follows the federal Code.  The Commissioner is correct in part in that the Massachusetts statute uses the federal gross income, as determined by the Code, as a starting point for determining a corporation's "gross income".  However, the Supreme Judicial Court has consistently held that income for federal and state purposes is not always the same.  See, e.g. Rohrbough, Inc. v. Commissioner of Revenue, 385 Mass. 830 (1982).
The reference is to the provisions of the Internal Revenue Code and not simply to the amount of gross income shown on a taxpayer's Federal income tax return for the same tax year.  Although the figure shown as gross income on a taxpayer's Federal return will normally be the gross income for State tax purposes for the same tax year, this is not always the case.  

Id. at 832.
In this case, the question is not a difference between CEI's federal and state gross income.  On both its federal consolidated and state combined returns, CEI included in Jamesbury's taxable income the gain recognized from the    § 338 election.  The issue here is whether those proceeds were to be included in the "sales factor."  The apportionment formula contained in G.L. c. 63, § 38 makes no reference to the Code.  Instead, this section defines the necessary terms.  The statute is clear that receipts generated from the sale of stock are not "sales" for purposes of the sales factor.  G.L. c. 63, § 38(f).  
Section 338 of the Code specifically states that "in the case of any qualified stock purchase ... [the corporation whose stock is being sold] shall be treated as having sold all of its assets."  I.R.C. § 338(a) (emphasis added).  In an analogous situation, the Board declined to attach Massachusetts tax significance to "a fictitious transaction deemed to have taken place for [federal] tax purposes."  Weston Marketing Corp. v. Comm'r of Revenue, 16 Mass. App. Tax Bd. Rep. 76, 80 (1994).  In Weston, the taxpayer was a holder of "regulated futures contracts."  Pursuant to § 1256 of the Code, the taxpayer was required at the end of the year to "mark-to-market" the commodities; that is, to recognize a gain or loss as if the commodities had been sold on the last day of the year.  On its 1981 federal tax return, the taxpayer reported a net capital loss, based on the mark-to-market rules, and reported no income on its state return.  In 1982, the taxpayer disposed of certain commodities and reported on its federal return a net capital gain, a portion of which reflected a recapture of the prior year's mark-to-market net loss.  On its state return for 1982, the taxpayer excluded the recapture of the prior year's loss reported on its federal return.
The Board concluded that although the Code required, for federal tax purposes, the recapture of losses taken for the prior year's "fictitious transaction," there was no "actual realization of income" subject to taxation in Massachusetts.  Weston, 16 Mass. App. Tax Bd. Rep. 76, 80.  See also Rohrbough, 382 Mass. 833; T.H.E. Investment Corporation v. Commissioner, 8 Mass. App. Tax Bd. Rep. 12 (1986)(taxpayer not required to include in state gross income the recapture of income generated from losses taken for federal, but not state, purposes in prior years.)
It is well established that "the right to tax must be found within the letter of the law and is not to be extended by implication."  Grady v. Commissioner of Revenue, 421 Mass. 374, 377 quoting Commissioner of Revenue v. Molesworth, 408 Mass. 580, 581 (1990). Tax statutes are to be starkly construed according to their plain meaning.  Commissioner of Revenue v. Franchi, 423 Mass. 817, 822.  All ambiguities in interpreting the statute must be resolved in favor of the taxpayer.  Grady, 421 Mass. at 374.
	Accordingly, the Board found that the federal treatment of the sale -- based on a fictitious recasting of the actual transaction for purposes of federal tax law -- does not determine whether the proceeds of the transaction should be treated as a "sales" for purposes of the Massachusetts apportionment formula.  Whatever the transaction may be "deemed" to be for federal purposes, it is, in actuality, a sale of stock, the proceeds from which are specifically excluded from the sales factor.
	The Commissioner's regulation, 830 CMR 38.1(9)(b)7, promulgated in August, 1995, long after the 1988 transaction at issue and after the instant appeal was filed, is not persuasive on the issue of how § 38 should be interpreted in this appeal.  The regulation was neither promulgated contemporaneously with the enactment of § 38 (See Xtra, Inc. v. Commissioner of Revenue, 380 Mass. 277, 282 (1980)) nor is it consistent with the plain wording of the statute.  See Electronics Corporation of America v. Commissioner of Revenue, 402 Mass. 672, 676-677 (1988).  
	


For all of the foregoing reasons, the Board issued a decision for the appellant in this appeal.

					       APPELLATE TAX BOARD

					   By:					__
						 Abigail A. Burns, Chairman

  						      
A true copy,

Attest:				_
   	  Clerk of the Board

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ATB  2000-217