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The saga of the proper definition of "business income" under the Uniform Division of Income for Tax Purposes Act (UDITPA) continues to unfold. UDITPA provides that "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 course of business operations." Most of the controversy continues to revolve around whether this definition contains both a "functional test" and "transactional test." In UDITPA states, the conflicting application of the term "business income" often results in disparate treatment of similar items of gain or income. Also, states that do not adopt UDITPA, but have statutes consistent with it, are at odds over how to interpret their definition of business income.
Generally, under the transactional test, income is business income if the transaction or activity that gave rise to the income occurred in the regular course of a taxpayer's trade or business. Under the functional test, income is business income if the acquisition, management and disposition of the property generating the income constitute an integral part of a taxpayer's regular trade or business.
In Polaroid Corp. (1998), the North Carolina Court of Appeals explicitly adopted the transactional test and rejected the functional test for defining business income. In Polaroid, the taxpayer received monetary damages related to a patent infringement lawsuit. Polaroid classified the damages as nonbusiness income and allocated the income to its state of commercial domicile. The appeals court rejected the...