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Pennsylvania High Court Decision Prompts Taxpayers to Rethink Proper Treatment of Gain


The Supreme Court of Pennsylvania held last week in Glatfelter that a taxpayer's gain from the sale of a tract of Delaware timberland constitutes business income subject to apportionment and tax in Pennsylvania. This marks the first time the Court has considered the business income issue since the Pennsylvania General Assembly amended the statutory definition of business income in 2001. The opinion is significant because the Court departed from its earlier precedent for treating as non-business income the gain from dispositions that are not integral to the taxpayer's regular trade or business. The Court based its reasoning on the amendments to the statutory definition of "business income," which the Court said altered the analysis despite the General Assembly's comment that the amendments were merely intended to clarify existing law. When preparing Pennsylvania Corporate Net Income Tax reports and financial statements, taxpayers must be aware of the expanded definition that Pennsylvania can be expected to apply going forward in an attempt to garner as much revenue as possible from multistate taxpayers. However, under the right set of facts, the broadened definition could work to a taxpayer's advantage and present a potential refund opportunity. For example, a taxpayer that has treated gain on the sale of Pennsylvania real property as non-business income or a Pennsylvania domiciled taxpayer that has treated a major gain as non-business income should consider filing a refund claim.


Pennsylvania's statutory definition of business income includes the so-called "functional test" which focuses on how property is acquired, managed, and disposed of by the taxpayer. Prior to 2001, under the functional test, business income included "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." The Supreme Court of Pennsylvania interpreted the conjunctive nature of the pre-2001 test as requiring all three factors – the acquisition, management, and disposition of property – to be integral parts of the taxpayer's regular trade or business operations in order for the gain therefrom to be treated as business income. Therefore, if, for example, the disposition of property was not an integral part of the taxpayer's regular business, the gain could not be treated as business income. In a key decision interpreting the functional test, the Court in Laurel Pipeline Co. v. Commonwealth, 642 A.2d 472 (Pa. 1994), held that gain from a disposition of assets characterized as a liquidation of a separate and distinct aspect of the taxpayer's business does not constitute business income. Similarly, gain from a deemed sale of assets in liquidation resulting from an election under IRC § 338(h)(10) does not constitute business income. See Canteen Corp. v. Commonwealth, 818 A.2d 594 (Pa. Cmwlth. 2003), aff'd 854 A.2d 440 (Pa. 2004).

In 2001, the General Assembly modified the statutory language of the functional test. Under the current statute, business income "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." The General Assembly stated in the relevant Act that the intent of the amendment was to clarify existing law, thus leaving open the argument that Laurel Pipeline and Canteen Corp. remain good law even after the change from "and" to "or."

The Opinion

In Glatfelter Pulpwood Company v. Commonwealth, No. 62 MAP 2011 (Pa. Jan. 22, 2013), the Supreme Court of Pennsylvania upheld the Commonwealth Court's determination that Glatfelter's sale of timberland used in the production of pulpwood for sale to its parent resulted in apportionable business income. Glatfelter's primary business is the procurement of pulpwood – either from its own timberlands or by purchase from third parties – which Glatfelter sells to its parent for use in its parent's paper mill operations. In 2004, as part of a timberland divestiture plan, Glatfelter sold about a quarter of its Delaware timberlands and distributed the proceeds to its parent. After initially treating the gain as business income on its Pennsylvania Corporate Net Income Tax return, Glatfelter filed an amended return reporting the gain as non-business income allocated to Delaware and requested a refund. Glatfelter paid over $4.5 million of corporate income tax on the sale to Delaware.

The Court held that the gain constituted business income under the plain language of the amended definition because the timberlands were managed as part of Gladfelter's regular trade or business and therefore it was not necessary for the Court to consider whether the disposition was integral to Gladfelter's regular trade or business. The Court placed much weight on the language of the amended statutes, but in doing so it failed to discuss at any length the implications of the General Assembly's comments that the amendments were merely clarifications of existing law. These comments lead one to believe that a disposition treated as a liquidation should still be treated as non-business income. However, the impact of the Glatfelter decision is yet to be determined. Both the Commonwealth Court and the Pennsylvania Supreme Court determined that Glatfelter's timberland sale was not a liquidation but merely a disposition of assets used to produce business income. Accordingly, despite the Court's decision to ignore the pertinent legislative history and expand the business income definition, the question remains whether taxpayers may continue to treat gains from dispositions treated as liquidations as non-business income under Laurel Pipe and Canteen Corp. Until the Court decides a liquidation case, we believe there is a position to treat gains from dispositions treated as liquidations as non-business income.

Looking Ahead

It appears taxpayers may be stuck with the result in Glatfelter, at least with respect to non-liquidating dispositions. Unfortunately, we are left without definitive guidance for the proper treatment of gains from partial, complete, and deemed liquidations. Taxpayers should consider this case before filing Corporate Net Income Tax reports or disposing of business assets. 

In addition, taxpayers that reported large gains as non-business income assigned to Pennsylvania based on the prior interpretation of the Pennsylvania law should consider whether the expanded definition could result in a refund opportunity under their specific fact pattern. 



IRS Circular 230 Disclosure: To comply with certain U.S. Treasury regulations, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication, including attachments, was not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding any penalties that may be imposed on such taxpayer by the Internal Revenue Service. In addition, if any such tax advice is used or referred to by other parties in promoting, marketing, or recommending any partnership or other entity, investment plan, or arrangement, then (i) the advice should be construed as written in connection with the promotion or marketing by others of the transaction(s) or matter(s) addressed in this communication and (ii) the taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor. To the extent that a state taxing authority has adopted rules similar to the relevant provisions of Circular 230, use of any state tax advice contained herein is similarly limited.


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Donald M. Griswold
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Phone: +1 202.624.2926