Pennsylvania ~ Corporate Income Tax: Gain on Sale of Timberland Was Business Income

The Pennsylvania Supreme Court affirmed a lower court’s decision that a taxpayer’s gain from the sale of timberland met the definition of “business income,” for corporate income tax purposes, and denied the taxpayer’s request for a tax refund. The taxpayer was a wholly owned subsidiary of a parent that was engaged in the business of manufacturing specialty papers and engineered products and had timberlands located in Delaware, Maryland, Pennsylvania, and Virginia. The taxpayer’s sole business activity was the procurement of pulpwood from either company-owned timberland or from unrelated third parties.



In the year prior to the tax year at issue, the taxpayer, based on a business decision, began selling off some of its company-owned timberland, reducing the percentage of pulpwood received from company timber from 25% to 5%. In the year at issue, the taxpayer sold off some acres in Delaware (Delaware sale) and realized a net gain of $55 million and reported this on its federal return as a sale or exchange of property used in a trade or business. The taxpayer then distributed all of the proceeds from this sale to its parent, who then used it to pay off debt and to pay dividends. Although the sale of pulpwood in prior years was reported to Pennsylvania as apportionable business income, the taxpayer filed an amended return claiming the net gain from the Delaware sale was nonbusiness income to be allocated to Delaware. The state revenue department then increased the apportionable business income from a net loss to $52 million through its denial of the nonbusiness income treatment of the Delaware sale. The taxpayer appealed and requested a refund, but the commonwealth court denied the request, finding that the sale met the definition of “business income.”


Business Income

The taxpayer contended that the sale of the timberland did not meet the transactional test because it did not regularly deal in the business of selling or speculating in real estate. Its regular and routine business was the procurement and sale of harvested pulpwood to its parent. The taxpayer also argued that the disposition of the land was not business income as it was not a routine occurrence in its regular business operation because it constituted a partial liquidation of a unique aspect of its assets, and the net gain should be allocated to Delaware, where the real property was located, as nonbusiness income. The state argued that the sale of the timberlands was business income because the timberlands, from their acquisition to their management to their disposition, were wholly integrated into the taxpayer’s business operations and generated business income during the time they were owned by the taxpayer. The court noted that the statutory definition of business income included “income from tangible and intangible property if either the acquisition, the management, or the disposition of the property” was part of the taxpayer’s regular business. The taxpayer’s own stipulations established that the acquisition and the management of its timberland constituted integral parts of its regular business operations. Because the disposition of the property was a part of the taxpayer’s regular business operation, the gain from the sale of the timberlands constituted business income.



The taxpayer’s next argument was that the gain on the Delaware sale should have been excluded from its taxable base, regardless of whether it was business or nonbusiness income, because the parent’s real estate was located in Delaware and was unrelated to its regular business activities in Pennsylvania. The court, in deciding this apportionment issue, looked to a previous Pennsylvania Supreme Court case that laid out factors to consider. Based on that decision and the stipulated facts of this case, the court found that the Delaware timberland was integrally related to the taxpayer’s business activities in Pennsylvania. The Delaware sale was not a liquidation but the disposition of property that was used in producing business income; therefore, income from the Delaware sale was subject to tax in Pennsylvania as business income.


Due Process and Commerce Clauses

Finally, the taxpayer argued that it was unfairly taxed under the Due Process and Commerce Clauses of the U.S. Constitution because Pennsylvania’s apportionment was unfair. The taxpayer asserted that application of the apportionment formula to the gain from the sale of its timberland was unfair because there was no rational relationship between the sale and the taxpayer’s Pennsylvania operations or activities, and because the income attributed to Pennsylvania was out of all proportion to the business the taxpayer transacted in Pennsylvania. The court concluded that the taxpayer was a unitary business, and, as such, the taxpayer was properly subject to corporate income tax in Pennsylvania as calculated pursuant to the state’s apportionment formula.


Glatfelter Pulpwood Co. v. Commonwealth of Pennsylvania , Pennsylvania Supreme Court, No. 62 MAP 2011, January 22, 2013 , ¶204-250






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