Commonwealth v. Kirby Estates, Inc.

246 A.2d 120, 432 Pa. 103, 1968 Pa. LEXIS 490

• Court: Supreme Court of Pennsylvania
• Decided: October 3, 1968
• Docket: Appeal, 40
• Status: Published

Opinions

Opinion by

Me. Justice Cohen,

This is an appeal by the Commonwealth involving the franchise tax imposed upon Kirby Estates, Inc. for the year 1962.

Kirby Estates, Inc. (taxpayer) is a Delaware corporation organized in 1943 as an investment and holding company. Until 1961 taxpayer engaged solely in the business of investing in stocks and securities, its activities in this respect being carried on wholly outside Pennsylvania. These activities continued in a similar fashion during 1962.

However, during December, 1961, taxpayer, by action of its board of directors acquired a tract of real estate in Erie, Pennsylvania, for the sum of $77,565.57. It paid for this real estate by giving cash in the amount of $32,565.57 and securing a mortgage from an Erie bank for $45,000. All of the cash was drawn from its earnings; none came from the sale of any stocks or securities. At the same time taxpayer registered to do business in Pennsylvania.

Taxpayer’s Pennsylvania real estate was rented to unrelated tenants. It was managed for taxpayer by an Erie firm which received a monthly management fee. In 1962 taxpayer received rental income from the property of $10,692.60 and incurred expenses in connection therewith of $10,045.78, leaving a net income of $646.82.

In computing its 1962 franchise tax, taxpayer valued its capital stock at $30,450.36 by taking the December 31, 1962, depreciated book value of its Pennsylvania real estate and subtracting therefrom the December 31, 1962, mortgage balance. To this figure it applied a taxable proportion of 100% (all of the factors attributable to its real estate activity were in Pennsylvania) and applied the five mill tax rate to obtain a tax of $152.25.

The Commonwealth, however, refused to let taxpayer eliminate its securities activity in this fashion. It settled the tax by including both the real estate and securities in determining the value of taxpayer’s capital stock. This produced a value of $1,400,000. Application of the allocation fractions (100% for tangible property, no compensation fraction at all, and slightly less than 13% of all receipts) produced a/taxable proportion of .564963, a taxable value of $790,-948 and a tax of $3,954.74.

Taxpayer, feeling somewhat aggrieved that its $77,-565.57 investment in Pennsylvania had produced net income of $646.82 and a Pennsylvania franchise tax of $3,954.74, appealed. Holding that the inclusion of taxpayer’s securities in computing the value of its capital stock for franchise tax purposes produces an unreasonable result, one out of proportion to the business conducted in Pennsylvania and hence, unconstitutional, the lower court sustained taxpayer’s objections and determined the correct tax to be $152.25 as reported. The Commonwealth then appealed.

At the time we initially sustained the Act of May 16, 1935, P. L. 184, adding the franchise tax provisions to the Act of June 1, 1889, P. L. 420, as amended, 72 P.S. §1871, we indicated that the tax was one upon the privilege of doing business in Pennsylvania and that to be validly imposed it must be applied only to that part of the business conducted in this Commonwealth. Commonwealth v. Columbia Gas & Electric Corporation, 336 Pa. 209, 8 A. 2d 404 (1939). In Columbia we commented: . . since the tax is nothing but one upon the value of a privilege and the taxable measure is fundamentally the capital stock used in connection with that privilege, we must for the purpose of determining the validity of the tax separate from it that capital stock value which bears no relation to the privilege.” 336 Pa. 209, 225-226, 8 A. 2d 404, 413. Thus we required in Columbia separation of the company’s outside holding company business from its Pennsylvania operating business and sustained the tax only upon the latter.

Subsequently, in Commonwealth v. Mundy Corporation, 346 Pa. 482, 30 A. 2d 878 (1943), we directed computation of the franchise tax by excluding the value of securities owned and held by the company in Pennsylvania during the year from the value of its capital stock, and by including only the value of Pennsylvania real estate owned by it and rented to others. We noted that the company’s business was real estate, and that the holding of the securities did not constitute the doing of any business here. See also, Commonwealth v. Baxter, Kelly & Faust, Inc., 53 Dauph. 73 (1942), for another application of this concept of unrelated assets.

The Commonwealth argues here that taxpayer was engaged throughout 1962 in a single business—investing—and that its outside securities investment activity and its Pennsylvania real estate activity are part and parcel of a single enterprise. This may be assumed for our purposes, but we believe it misses the mark. What the Commonwealth has done is to find the broadest umbrella it can locate to cover all of taxpayer’s activities and then has enveloped the latter in a general conclusion. The same argument could be made in connection with a hypothetical corporation manufacturing space rockets in Pennsylvania and women’s clothes in Idaho in a way totally unconnected with each other.¹ True, the corporation is conducting one activity-—manufacturing—hut this designation does not begin to meet the issue.

The question now as it has always been, is what is the value of the corporate franchise being exercised in Pennsylvania, and has there been eliminated therefrom all elements of value bearing no relation to the exercise of the privilege of doing business here? Whether we speak of multiform business activity or unrelated assets, this question remains the same. Here, it is obvious that taxpayer’s presence in Pennsylvania was limited to its ownership of real estate and that its activity in connection therewith was neither enhanced nor diminished by its securities activity outside Pennsylvania. The two were unconnected in the traditional sense even though they may be broadly joined and categorized by the descriptive verb “investing.” For this reason we sustain taxpayer’s position.

Judgment affirmed.

1 By “unconnected” we mean in the sense that each operates independently and neither contributes directly to the operation of the other, not in the sense that the corporation as a whole does not benefit. For this reason, for example, we attach no importance to the fact that taxpayer maintains a single bank account rather than one for each activity.