In the Matter of the Appeal of Kroger Co.,Docket No. 93-15316-DT
Corporate Income Tax
Whether the sale or assignment of leasehold interests is in the regular course of the taxpayer's trade or business.
BEFORE THE BOARD OF TAX APPEALS OF THE STATE OF KANSAS
IN THE MATTER OF THE APPEAL
OF KROGER CO. (THE),
FROM AN ORDER OF THE DIRECTOR OF
TAXATION ON ASSESSMENT OF
CORPORATE INCOME TAXES FOR FISCAL YEARS
12/28/85 THROUGH 12/31/88
Docket No. 93-15316-DT
O R D E R
Now, on this 3rd day of February, 1997, the above-captioned matter comes on for consideration and decision by the Board of Tax Appeal of the State of Kansas.
Both parties waived an evidentiary hearing in this matter and elected to have the Board consider this case on the record made before the Director of Taxation. After considering all of the evidence presented therein, and being fully advised in the premises, the Board finds and concludes as follows:
1. The Board has jurisdiction of the subject matter and of the parties, a proper and timely appeal having been filed, pursuant to K.S.A. 74-2438.
2. The issue for the Board is whether the sale or assignment of leasehold interests is in the regular course of the Taxpayer's trade or business.
3. On 15 August 1990, the Department issued a corporate income tax assessment to Kroger for $673,085. The assessment was based upon the business income classification of gains from the 1986 and 1987 dispositions of Kroger's drug stores.
4. During the 1985 through 1988 audit period, the Kroger Company and all its affiliates were a unitary business. Kroger'' main business is the retail sales of groceries. Kroger also had ancillary enterprises such as food processing, drug stores, and convenience stores. In 1986, Kroger liquidated its drug store line.
5. The dispositions of the stores were by assigning leases to third parties. The lease terms were below market rates, and the assignment was made at the market rates. Consequently, upon disposition of these leasehold interests, a gain resulted. In some instances, Kroger received stock in some of these other corporations in order to facilitate the transaction.
6. On its tax returns, Kroger deducted $200,000,000 of these gains as non-business income. This amount came from the gains resulting from the dispositions of the drug stores.
7. Kroger systematically acquired and disposed of its stores in the regular course if its business. Between 1980 and 1988, an average of 522 stores were acquired or disposed of per year. This is part of what Kroger determined to be its flexible responsiveness. Consequently, these store dispositions occurred in the regular course of Kroger's business when measured by its past practices of acquiring and disposing of stores. In 1988, Kroger restructured again.
8. In it Brief, the Department argues that Kroger had a business strategy which necessitated that it open and close stores on a regular basis. Despite the turnover in stores, Kroger's tangible assets never materially changed. Therefore, the regular course of Kroger's business included opening and closing stores, and the gain from this should be included in the business income.
9. The Department also argues that Kroger is inconsistent in its application of business expenses and non-business income. The Department argues that Kroger is characterizing the restructuring expenses as business expenses, thus having it both ways.
10. Kroger argues that the sales which caused the gain at issue here occurred only pursuant to a 1986 restructuring, and did not occur prior to that restructuring, and have not occurred since that restructuring. The one-time sale of these lease equities is not a regular part of the business. To be sure, constant review of its asset is normal for Kroger; however, the sale of assets is not in the regular course of business for Kroger. The restructuring consisted of Kroger liquidating its drug stores.
11. In an Interrogatory to the Department, Kroger states that the sale of the leases was a business decision based on what would generate the greatest value for the company. It was not a tax motivated consideration.
12. Kroger argues that this case is different from other cases in that no real estate (land, buildings, or equipment), rental, royalty or interest involved as transferred.
13. Kroger further argues that the 1986 and 1988 restructuring were two different and separate transactions that had nothing to do with each other. The 1986 restructuring was part of a business decision to abandon a line of business. The 1988 restructuring was part of an attempt to fend off a hostile takeover.
14. With regard to the deduction of certain expenses, Kroger argues that it had already deducted those expenses when the gain was computed, thus making the gain a net gain.
15. The issue here is whether the sale of Kroger's leasehold interests was in the regular course of Kroger's business in order to determine if the gain is business income.
16. The applicable law can be found in K.S.A. 79-3271(a), which states:
"Business income": means 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 the acquisition, management, and disposition of the property constitute integral parts of the taxpayer's regular trade or business operations.
17. Non-business income is defined as all income other than business income. K.S.A. 79-3271(b).
18. heretofore, two tests to determine business income were arguably used in this situation, the transactional test and the functional test. In
In re Tax Appeal of Chief Industries, Inc
., 255 Kan. 640, 875 P.2d 278 (1994) (BOTA Docket Number 91-7191-DT) the Kansas Supreme Court, in a 4-3 decision made its determination as to which test to follow.
court upheld the narrowly defined transactional test set forth in
Western Natural Gas Co. v. McDonald
, 202 Kan. 98, 446 P.2d 781 (1968) and found that the functional test was not applicable in Kansas. The Court stated, "The test to be applied is the transactional test set forth [in
Western Natural Gas
] . . . as being the test required by K.S.A. 79-3271(a)." In this case, the Department presents no arguments to apply the functional test. Therefore, the Board shall apply the transactional test.
20. Western Natural Gas is to be the overriding Kansas case in this area. In defining business income, the Western Natural Gas court held:
Business income includes income form intangible property if the acquisition, management and disposition giving rise to the income constitute integral parts of the regular trade or business operations. It is not the use of the property in the business which is the determining factor under the statute. The controlling factor by which the statute identifies income is the nature of the particular transaction giving rise to the income. To be business income the transaction and activity must have been in the regular course of taxpayer's business operations
202 Kan. at 100-01.
Western Natural Gas
, Western liquidated all of its assets. This complete plan of liquidation required the affirmative vote of its stockholders. The Court found that the liquidation was not made in Western's regular course of business operations when measured by its former practices. It had not sold oil and gas leases in the past, and the sale contemplated the cessation of business rather than the continued operation of business.
22. Courts in other states, when defining the transactional test, tend to look at the past business practices of the Taxpayer to determine what is the regular course of that business. In
Ross-Araco, Corp. v. Commonwealth of Pennsylvania
, 644 A.2d 235, 237 (Pa.Commw. Ct. 1994), the Court compared the transaction in question with similar transactions of the Taxpayer's past business practices to ascertain their frequency and regularity. The
court cited the maxim that statutory provisions imposing tax must be strictly construed. The court distinguished primary from the secondary business activities of the taxpayer. Income derived from these secondary business activities were much less likely to be included in the business income.
court also found that a gain used for on-going or future business operations is considered business income, and gain from the sale of assets pursuant to business liquidation is non-business income. Id. at 237.
, the taxpayer, a local construction company sold a large portion of its land at a sizable gain. The only other real estate sold by Ross-Araco was its office building when it moved to a different location.
25. The facts in this case indicate that Kroger regularly opens and closes grocery stores throughout its territory. However, any gains resulted from such transactions are not at issue here. Kroger's closing of certain grocery stores here and there is not the same thing as closing all of its pharmacies.
26. The gains at issue here were derived from the abandonment of a line of Kroger's business. Kroger's past business practices do not indicate that it regularly abandons certain lines of its business. The 1988 restructuring was the product of an action which is also not in the regular course of Kroger's business. More importantly, the 1988 restructuring occurred after the 1986 restructuring and would be irrelevant in determining the past business practices of Kroger in 1986.
27. The Board finds that in light of
the Western Natural Gas
decision, it is clear that in this case the gain on the sale of leasehold interests is not business income.
IT IS THEREFORE ORDERED BY THE BOARD OF TAX APPEALS OF THE STATE OF KANSAS that the gains from the lease assignments of the 1986 restructuring shall not be considered business income. The Department of Revenue is hereby ordered to recalculate Kroger's corporate income tax liability in conformance with this Order for the audit period at issue here.
Any party to this appeal who is aggrieved by this decision may file a written petition for reconsideration with this Board as provided in K.S.A. 1995 Supp. 77-529. The written petition for reconsideration shall set forth specifically and in adequate detail the particular and specific respects in which it is alleged that the board's order is unlawful, unreasonable, capricious, improper or unfair. Any petition for reconsideration shall be mailed to Secretary, Board of Tax Appeals, SDOB Suite 451, 915 SW Harrison St., Topeka, KS 66612-1505.
A copy of the petition, together with all accompanying documents submitted, shall be mailed to the opposing party at the same time the petition is mailed to the Board. Failure to notify the opposing party shall render any subsequent order voidable
. The written petition must be received by the Board within fifteen (15) days of the certification date of this order (allowing an additional three days for mailing pursuant to the statute if the Board serves the order by
). If at 5:00 pm on the last day of the specified period the Board has not received a written petition for reconsideration, this order will become a final order from which no further appeal is available.
IT IS SO ORDERED THE BOARD OF TAX APPEALS
AUGUST BOGINA, JR. P.E., CHAIRMAN
FRED J. HIRSCH, MEMBER
RITA MAICHEL, SECRETARY J. LYN ENTRIKIN GOERING, MEMBER
CARL EDWARDS, ATTORNEY ROBERT G. FREY, MEMBER
I., Rita Maichel, Secretary of the Board of Tax Appeals of the State of Kansas, do hereby certify that a true and correct copy of the order in Docket No. 93-15316-DT and any attachments thereto, was placed in the United States Mail, on this 13th day of February, 1997, addressed to:
John H. Wachter, Attorney at Law Manager, Federal & State Inc. Tax
Porter, Fairchild, Wachter, Haney The Kroger Company
P.O. Box 1833 1014 Vine Street
Topeka, KS 66502 Cincinnati, OH 45201
and a copy was placed in capitol complex building mail, addressed to:
Director of Taxation David Prager, III, c/o.
DSOB, 915 S. Harrison, 1st Floor General Counsel, Dept. of Revenue
Topeka, KS 66612 DSOB, 915 SW Harrison, 2nd Fl
Topeka, KS 66612
IN TESTIMONY WHEREOF, I have hereunto subscribed my name at Topeka, Kansas.
Rita Maichel, Secretary
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