A Pennsylvania paper company’s pulpwood supplier has lost its bid to avoid corporate tax liability on a multimillion-dollar sale of thousands of acres of timberland holdings the supplier had owned in Delaware.

The state Supreme Court’s five-justice majority largely rendered its opinion based on changes the state General Assembly made in 2001 to the state’s Tax Reform Code of 1971, namely the ostensible broadening of what classifies as "business income." The pulpwood supplier, Glatfelter Pulpwood Co., also failed to persuade the court that the sale of its Delaware timberland was unrelated to its regular business in Pennsylvania and that imposing Pennsylvania taxation of the net gain of the sale would be duplicative and unconstitutional.

The company’s sole business activity is to provide pulpwood to P.H. Glatfelter Corp., a paper supplier. 
Justice Seamus P. McCaffery devoted a hearty portion of his 31-page opinion to the language in the amended Tax Reform Code, which defines 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 either the acquisition, the management or the disposition of the property constitutes an integral part of the taxpayer’s regular trade or business operations."

McCaffery noted the General Assembly changed language in the statute from conjunctive — "acquisition, management and disposition" — to disjunctive — "the acquisition, the management or the disposition" of the property. Both of these definitions require the property to be "an integral part of the taxpayer’s regular trade or business operations," but the critical word for the majority was "’or.’"

"The General Assembly chose to employ the disjunctive conjunctions ‘either/or’ in this definition, and its meaning is clear and unambiguous," McCaffery said. "For a gain from the sale of property to be classified as business income, the acquisition or the management or the disposition of that property must constitute an integral part of the taxpayer’s business operations."

The analysis follows an application of the high-court-crafted "functional test," which says, according to McCaffery, that a gain from the sale of an asset is business income if the corporation acquired, managed or disposed of an asset if that asset is an integral part of the company’s regular business.

And McCaffery said it was by Glatfelter’s own admissions that the acquirement and management of the Delaware timberlands — some 19,249 acres, of which it sold 4,882 in 2004 — reflected integral parts of Glatfelter’s business.

Glatfelter had relied on a previous high court decision, Laurel Pipe Line v. Commonwealth, to apply the functional test in arguing that where a taxpayer company liquidates a unique asset and does not reinvest the proceeds (it used the Delaware timberland money to pay off debt to compensate shareholders, the opinion said), such does not amount to "business income." Glatfelter argued the high court, through Laurel, carved out an exception for gains from the partial liquidation of a company business.

In McCaffery and the majority’s views, however, the company did not pay attention to the statute that controlled its case and, as McCaffery mentioned, was updated after Laurel came down in 1994.

"Whether the disposition of the timberland was also an integral part of [Glatfelter's] regular business operations, pursuant to this court’s precedent in Laurel Pipe, is not a matter that we need reach because only the acquisition or the management or the disposition of the property at issue need be an integral part of the taxpayer’s regular business operations under the plain text of the current statute," McCaffery said.

Another test, which did not apply to Glatfelter Pulpwood v. Commonwealth, was the "transactional test," designed to test the first clause of the definition of business income related to the type of transactions that produced the gain and whether the corporation regularly engages in those types of transactions.

The court’s January 22 decision came over a dissenting opinion from Justice J. Michael Eakin, who said he thought the facts in Glatfelter were stronger than those in Laurel. Eakin also pointed out that the Laurel decision was not based on the "conjunctive nature" or the prior legislation, suggesting the majority had given misplaced emphasis to the new disjunctive language.

"Changing to the disjunctive did absolutely nothing to alter the reasoning of the court, which properly focused on whether the transaction was an integral part of Laurel’s regular trade or business," Eakin said.

The three-page dissent also examines the "continued viability" of the court’s test when that test is based on legislation that is subsequently changed.

Eakin said the General Assembly’s amending the statute, found at 72 P.S. Section 7401(3)2.(a)(1)(A), was a "change to the very language from which the function test was divined."

He went on: "The amendment does not address the analysis of Laurel — what it does is modify the language on which the function test is based. If anything, a significant change to that language suggests a need to re-examine the continued viability of a test which is based on the pre-amendment language. Where a test is an interpretation of a clause that is subsequently changed, it is the test itself that is in question."

The majority also rejected Glatfelter’s argument that, even if the net gain from the sale of the timberland is business income, it should not be subjected to Pennsylvania business tax because the Delaware land was unrelated to Glatfelter’s regular business activities in Pennsylvania.

Glatfelter also argued it had been unconstitutionally subjected to double taxation on a portion of its net gain from the sale of timberland, asserting violations of the due process and commerce clauses of the U.S. Constitution. According to the opinion, Delaware imposed its corporate tax rate of 42 percent of the sale’s net gain, while Pennsylvania imposed its own rate on 100 percent of the sale’s net gain; the opinion said Glatfelter’s net gain was more than $55 million.

The court disagreed, finding that all of the pulpwood Glatfelter procured, whether grown itself or bought on the open market, was used for the sole purpose of supplying its parent company with pulpwood to process at its paper mill.

Eakin did not analyze the unrelated-asset and double-taxation arguments, only touching on the latter in a passing footnote in which he suggested the "line of constitutional acceptability should be drawn somewhere short of taxing 142 percent of the sale proceeds, as was the result here."

The dispute dates back to 2004, when Glatfelter reported corporate net income tax liability of more than $2 million, which it paid. Afterward, however, the company amended its report, saying the $55 million net gain from the timberland sale should have been considered non-business income, therefore giving the company a net loss on the year and a tax liability of zero.

The department of revenue disagreed and the case went on up, with the company losing at every level.

Glatfelter’s attorney, George T. Bell of Morgan, Lewis & Bockius in Harrisburg, said the dispute has saddled his client with more than $5 million in payments it should not have paid.

Bell said one of the arguments his client was making was that the 2001 changes were merely intended to "clarify the [old] statute," and that Laurel should control, a position that Eakin echoed.

Bell added: "The court certainly could have held that while the cut timber made into pulpwood was related to Glatfelter’s activities in Pennsylvania, the sale of the timberlands in Delaware was not."

Jonathan C. Edmunds, of the Attorney General’s Office, offered the following comment on behalf of the office: "We are pleased that the Supreme Court has clarified the definition of business income and found that Pennsylvania’s treatment of the gain from Glatfelter Pulpwood Company’s sale of timberland as business income was proper and constitutionally sound."

Ben Present can be contacted at 215-557-2315 or bpresent@alm.com. Follow him on Twitter @BPresentTLI.

 (Copies of the 34-page opinion in Glatfelter Pulpwood v. Commonwealth, PICS No. 13-0167, are available from Pennsylvania Law Weekly. Please call the Pennsylvania Instant Case Service at 800-276-PICS to order or for information.) •