United States: Washington Board Of Tax Appeals Holds Merger Extension And Termination Fees Were Isolated Sales Not Subject To B&O Tax

The Washington Board of Tax Appeals has granted a taxpayer's motion for summary judgment and held that extension and termination fees that the taxpayer received pursuant to a merger agreement were casual or isolated sales that were not subject to the state's Business & Occupation (B&O) tax.1 The fees resulted from isolated sales of contract rights rather than routine transactions that were integral to the taxpayer's manufacturing business.

Background

The taxpayer was a Washington corporation that manufactured and sold abrasive waterjet cutting machines.2 In September 2008, the taxpayer, its largest shareholders, and Flow International Corporation (Flow) agreed that the taxpayer's shareholders would sell their stock to Flow in exchange for cash and shares of Flow's stock. Following its completion, this transaction would make the taxpayer a wholly-owned subsidiary of Flow. This was the first merger agreement that the taxpayer and its shareholders had entered into since the taxpayer's incorporation in 1993.

The merger agreement was amended twice. In November 2008, the first amended agreement gave Flow until the end of March 2009 to complete the transaction. After Flow provided notification that it would be unable to conclude the transaction by the March 2009 deadline, the parties entered into a second amended agreement providing that Flow would pay the taxpayer a $2 million fee to extend Flow's deadline to August 15, 2009. Also, under the second amended agreement, Flow agreed to pay the taxpayer an additional termination fee of $4 million if Flow was unable to meet this extended deadline.

In May 2009, Flow decided not to proceed with the merger and paid the extension and termination fees. On its 2009 Washington B&O tax returns, the taxpayer reported both the $2 million extension fee and $4 million termination fee under the manufacturing B&O tax classification. The Washington Department of Revenue audited the taxpayer in 2011 and assessed additional tax on the $6 million that the taxpayer received from Flow, by applying the service and other B&O tax classification on such amounts. The taxpayer appealed the assessment to the Department's Appeals Division, which affirmed the assessment. After the taxpayer timely filed a notice of appeal with the Board, the taxpayer and Department filed their cross-motions for summary judgment.

Extension and Termination Fees Were Isolated Transactions

The Board granted the taxpayer's motion for summary judgment and confirmed that the entire $6 million in extension and termination fees received by the taxpayer was not subject to the B&O tax under either the manufacturing or service and other B&O tax classifications. In doing so, the Board explained that B&O tax is based on the "gross income of the business," which a Washington statute defines as "the value proceeding or accruing by reason of the transaction of the business engaged in."3 The taxpayer successfully argued that the Department improperly imposed B&O tax on the $6 million of extension and termination fees because the taxpayer engaged in the business of manufacturing waterjet cutting tools rather than the business of negotiating merger agreements. After emphasizing that the negotiated merger was an isolated activity in the taxpayer's 20-year corporate history, the taxpayer contended that the Department "has consistently (and properly) concluded that the measure of the B&O tax does not extend to consideration received from isolated transactions outside a taxpayer's regular business."

The taxpayer based its argument on three types of transactions that have been deemed to be beyond the scope of "the business engaged in" and thus beyond the reach of B&O tax. First, the taxpayer cited to a Washington statute and regulation that define a "casual or isolated sale" as "a sale made by a person who is not engaged in the business of selling the type of property involved."4 To support this argument, the taxpayer cited published determinations in which the Department applied the exclusion for casual or isolated sales to sales of intangible property such as stock and patent rights.5 Second, the taxpayer observed that an administrative rule describes a farmer's occasional provision of farming services to other farmers, for a fee, as "casual and incidental to the farming activity" and thus not subject to B&O tax for horticultural services.6 Third, the taxpayer noted that the Department has issued guidance explaining that it excludes from B&O taxation the amounts a taxpayer receives in legal settlements that do not compensate the business for lost business sales or income.7

In response, the Department argued that the extension and termination fees were subject to the B&O tax because the taxpayer received them in the course of "engaging in business." A Washington statute defines "business" to include "all activities engaged in with the object of gain, benefit, or advantage to the taxpayer or to another person or class, directly or indirectly."8 According to the Department, the taxpayer entered into agreements with Flow for the taxpayer's "own personal corporate gain" or for the benefit of others. A Washington statute defines "engaging in business" as "commencing, conducting, or continuing in business and also the exercise of corporate . . . powers."9 The Department argued that the taxpayer exercised its corporate powers and engaged in business for purposes of the B&O tax by entering into the second amended agreement with Flow.

The Department addressed the three items that the taxpayer used to support its argument. First, in response to the taxpayer's contention that the transaction was a "casual or isolated sale," the Department argued that the receipts were not the result of a "sale" because there was no transfer of property for valuable consideration. Second, the Department argued that the occasional sale rule for farming cited by the taxpayer was not applicable because there is a distinction between exercising corporate authority to enter into contracts and a farmer assisting a neighbour. Third, the Department contended that its guidance on legal settlements failed to support the taxpayer's argument because it did not provide an example showing how the Department would treat a settlement from a dispute concerning merger agreement transactions.

The Board agreed with the taxpayer's arguments and concluded that the taxpayer's receipts from Flow under the second amended agreement were not subject to B&O tax. Rather than being derived from the business the taxpayer engaged in, the receipts were derived from the taxpayer's "casual or isolated" sales that were not taxable. The statutory definition of "sale" includes tangible and intangible property, as well as real property.10 The Board explained that sales are "casual or isolated" if they are not "routine and continuous" or "an integral part of the business operation."11 In the instant case, the extension and termination agreements represented the taxpayer's sale of valuable contract rights. First, Flow purchased from the taxpayer for $2 million the right to complete the merger agreement during a certain extended period. Second, Flow was assured that the damages arising from its failure to complete the merger would be liquidated for $4 million. Therefore, the Board concluded that the taxpayer's sales of the contract rights to Flow were isolated and non-taxable sales rather than routine transactions that were essential to the taxpayer's manufacturing business.

Commentary

This is a favorable decision for taxpayers with isolated sales that should not be subject to B&O tax. In this case, the taxpayer was a manufacturer that previously had not engaged in any merger transactions during its 20-year history. As a result, the merger extension and termination fees were isolated transactions that were not part of the taxpayer's routine business operations. Companies that receive significant amounts for transactions that do not occur on a regular basis or revolve around events that do not normally happen should consider whether the decision in this matter provides support for completely excluding receipts from these transactions from the B&O tax base. This decision also demonstrates the aggressive position taken by the Department in applying the B&O tax and disallowing the exception for isolated or casual sales through its broad interpretation of what constitutes engaging in business. Despite the strong facts supporting the taxpayer's argument that the sales were isolated, the Department maintained that the sales were subject to B&O tax.

Footnotes

1 Omax Corp. v. Washington Department of Revenue, Washington Board of Tax Appeals, Docket No. 13- 158, Sept. 10, 2015 (published Sept. 29, 2015).

2 The taxpayer's articles of incorporation were filed in 1993 and provided that the "[t]he purpose of this corporation is to engage in any business, trade or activity which may lawfully be conducted by a corporation organized under the Washington Business Corporation Act."

3 WASH. REV. CODE § 82.04.080(1) (emphasis added).

4 WASH. REV. CODE § 82.04.040(2); WASH. ADMIN. CODE § 458-20-106.

5 Det. No. 87-212, 3 WTD 259 (1987); Det. No. 85-97A, 7 WTD 383 (1985).

6 WASH. ADMIN. CODE § 458-20-209(3)(a).

7 The taxpayer cited the Department's legal settlements guidance that is available at http://dor.wa.gov/content/getaformorpublication/publicationbysubject/taxtopics/legalsettlement s.aspx.

8 WASH. REV. CODE § 82.04.140.

9 WASH. REV. CODE § 82.04.150.

10 Lacey Nursing Center v. Department of Revenue, 11 P.3d 839 (Wash. Ct. App. 2000).

11 Id.; Budget Rent-A-Car v. Department of Revenue, 500 P.2d 764 (Wash. 1972).

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