               SUPREME COURT OF MISSOURI
                                           en banc


MINACT, Inc.,                                 )
                                              )
                        Respondent,           )
                                              )
vs.                                           )       No. SC93162
                                              )
Director of Revenue,                          )
                                              )
                        Appellant.            )

         Petition for Review of a Decision of the Administrative Hearing Commission
                     Honorable Sreenivasa Rao Dandamudi, Commissioner

                                  Opinion issued April 15, 2014

         The director of revenue appeals a decision of the Administrative Hearing

Commission holding that income from a “rabbi trust” used to fund a deferred

compensation plan for company executives does not constitute “business income” subject

to apportionment and taxation in Missouri pursuant to section 32.200, RSMo Supp.

2013. 1 “Business income” under section 32.200 “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.” The

Commission’s decision is reversed because the trust income is “business income” used

for the current operational purpose of attracting and retaining key employees and is,

therefore, subject to apportionment in Missouri.


1
    All statutory citations are to RSMo Supp. 2013.
                                           I. Facts

       MINACT, Inc., is a Mississippi corporation with operations in several states,

including Missouri. In 1988, MINACT established an executive deferred compensation

plan (Plan) for a group of managerial and executive employees. The Plan gives

participating employees the option to defer portions of their salaries and bonuses.

MINACT provides a discretionary matching contribution of up to 3% of an employee’s

yearly compensation. Approximately thirty employees have participated in the plan since

its inception. There are currently seven Plan participants, one of whom lives in Missouri.

       The Plan is a non-qualified federal deferred compensation arrangement authorized

by 26 U.S.C. section 409A. The fact that the Plan is “non-qualified” means that, unlike a

“qualified” plan, all income from Plan investments is part of MINACT’s taxable income

and the company does not receive a current deduction for its contributions to the Plan.

       In 1994, MINACT established a “rabbi trust” to fund the Plan and meet the

company’s future liabilities to Plan participants. 2 A rabbi trust is a trust established by

an employer to fund a non-qualified deferred compensation plan. To qualify as a rabbi

trust, the employer must be the grantor of the trust and must report the trust’s earnings as

income on the employer’s federal income tax return. The trustee must be an independent

third party that is granted corporate powers under state law. The trust assets are subject

to the claims of the employer’s general creditors. Trust assets and income can only be

used to pay benefits owed to employees under the deferred compensation plan.


2
 The term “rabbi trust” comes from an IRS ruling, which approved the use of a trust to
provide non-qualified deferred compensation benefits for rabbis.
Employees have no vested right to obtain benefits from the trust until they are entitled to

receive benefits under the terms of the underlying non-qualified deferred compensation

plan.

        MINACT timely filed its 2007 Missouri corporate income tax return and reported

$667,773 in “non-business” income, $455,395 of which was income from the rabbi trust.

The distinction between “non-business” and “business” income is important because a

taxpayer, like MINACT, with tax liabilities in multiple states, must apportion “business

income” to the various states in which the taxpayer conducts business while “non-

business income” is paid to the state in which the taxpayer resides. MINACT reported

and allocated all trust income to Mississippi and paid Mississippi income taxes on that

income. The Missouri director of revenue disallowed MINACT’s claim of non-business

income. Minact timely filed its notice of written protest.

        Minact conceded that it should have allocated $212,378 as business income

subject to apportionment for Missouri taxation. However, Minact maintained that all of

the trust income - $455,395 – was non-business income not subject to apportionment and

Missouri taxation. The director determined that the trust income was business income

subject to apportionment and taxation in Missouri.

        MINACT appealed to the Administrative Hearing Commission. The AHC

determined that the trust income was non-business income because it was “not

attributable to the acquisition, management, and disposition of property constituting an

integral part of MINACT’s regular business,” as required by section 32.200. The

director seeks review.


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                                   II. Standard of Review

         Review of the commission’s decision is governed by section 621.189. This

section authorizes judicial review of the commission’s decision. Section 621.193

provides that the commission’s decision will be affirmed “if the decision is authorized by

law and supported by competent and substantial evidence upon the record as a whole

unless clearly contrary to the reasonable expectations of the General Assembly.” Street

v. Dir. of Revenue, 361 S.W.3d 355, 357 (Mo. banc 2012) (internal quotations and

citations omitted). The commission’s interpretation of state revenue laws is reviewed de

novo. Custom Hardware Engineering & Consulting Inc. v. Dir. of Revenue, 358 S.W.3d

54, 56 (Mo. banc 2012). The commission's findings of fact will be upheld if the findings

are supported by substantial evidence on the whole record. Id.

                                        III. Analysis

         Under the multi-state tax compact 3 , business income is apportioned to Missouri

using a formula that calculates a percentage of a company's income attributable to

Missouri based on the company's property, personnel, and sales in Missouri. ABB C-E

Nuclear Power Inc. v. Director of Revenue, 215 S.W.3d 85, 87 (Mo. banc 2007), citing

section 32.200, article IV, section 9. Section 32.200 defines “business” and “non-

business” income as follows:

           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.

3
    Sections 32.200 through 32.240.

                                              4
          Nonbusiness income means all other income other than business
          income.

       Missouri utilizes two tests to determine whether income is business or non-

business. The “transactional test” determines whether the gain is attributable to a type of

business transaction in which the taxpayer regularly engages. The “functional test”

determines whether the gain is attributable to an activity--namely the acquisition,

management, and disposition of property--that constitutes an integral part of the

taxpayer’s regular business. ABB C-E Nuclear Power, 215 S.W.3d at 87.

       The trust income does not satisfy the transactional test. MINACT’s business is the

management of Job Corps Centers pursuant to its contract with the federal government,

not investing in and administering the trust.

       The trust income does, however, satisfy the functional test for business income.

MINACT admitted that it established the Plan and funds the rabbi trust in order to attract

and retain key employees. Courts have recognized the obvious proposition that attracting

and retaining key employees is an important business purpose. See, e.g., Hoechst

Celanese Corp. v. Franchise Tax Board, 106 Cal. Rtr. 548 (Cal. 2001); Estate of True v.

C.I.R., 2001 WL 761280 (U.S. Tax Ct. 2001). A successful business requires capable,

productive management and executive leadership management just as it requires the tools

of its trade. By providing additional retirement compensation for its executives,

MINACT provides an incentive to attract and retain top executives for the purpose of

sustaining its current business operations. Consequently, the trust income is “business

income” under the functional test because it is a gain that is attributable to the acquisition,


                                                5
management, and disposition of property that constitutes an integral part of the taxpayer’s

regular business. The AHC erred in concluding otherwise.

       MINACT raises two main arguments in opposition to this conclusion. First,

MINACT asserts that the due process and commerce clauses of the United States

Constitution prohibit Missouri from taxing the trust’s income because the trust is located

in Mississippi. In order for Missouri to tax MINACT’s trust income, the trust income

must serve an “operational function” as opposed to an “investment function.” Allied

Signal, Inc. v. Director, Division of Taxation, 504 U.S. 768, 788 (1992), citing ASARCO,

Inc. v. Idaho State Tax Commission, 458 U.S. 307, 326 (1982).

       In Allied Signal and ASARCO, the companies invested in securities to obtain

profit. Profit is, of course, the underlying purpose of any for-profit business. If,

however, one state can tax all business profits derived in another state, constitutional

limits on interstate business taxation are rendered largely illusory. Thus, the court held in

both cases that a state could not tax these out-of-state profits as in-state income because

the fact that an intangible asset serves a long-term business purpose “does not convert an

otherwise passive investment into an integral operational one.” Allied-Signal, 504 U.S. at

788.

       MINACT contends that the trust income in this case is, like the income in

ASARCO and Allied Signal, passive investment income that may have a long-term

business purpose but which serves no present, integral operational purpose. MINACT

correctly recites the import of both cases, but neither case is dispositive of the particular

circumstances of this case. As established above, MINACT created the trust to attract


                                              6
and retain key employees in order to sustain its current business operations.

Consequently, neither ASARCO nor Allied Signal bars Missouri from apportioning and

taxing the trust income in this case.

       Second, MINACT contends that the trust income cannot satisfy the functional test

for business income because it has no authority to control or manage the trust because the

trust is administered by a third-party trustee. MINACT cites Siegel-Robert, Inc. v.

Commissioner of Revenue, Docket No. 00-3763-III (Tenn. Chancery Ct. 2006), Siegel-

Robert, Inc. v. Johnson, 2009 WL 3486625 (Tenn. App. 2009); and Sperry & Hutchinson

Co., v. Dept. of Revenue, 527 P.2d 729 (Ore. 1974). None of these cases are binding

and, in any event, each is materially distinguishable from this case.

       In both Siegel-Robert cases, the Tennessee court held that a corporation’s interest

earned on United States Treasury security investments was non-business income because

the interest income was not earned in the regular course of business. Similarly, in Sperry,

the court held that interest income from a long-term passive investment was not business

income because neither the capital nor the interest income was derived from the

taxpayer’s regular business. It is true that this case is similar to the Siegel-Robert cases

and Sperry insofar as the trust income in this case is not derived from MINACT’s

business of managing Job Corps centers. Unlike these cases, however, the underlying

purpose of the trust income in this case is to attract and retain the employees who do in

fact perform MINACT’s regular business. MINACT did not establish the Plan and the

trust for an altruistic purpose or to achieve a non-business, ultra vires purpose. To the




                                              7
contrary, MINACT created the Plan and the trust specifically to facilitate the current

operational purpose of retaining and attracting key employees.

       The trust income in this case is “business income” used for the current operational

purpose of attracting and retaining key employees and is, therefore, subject to

apportionment in Missouri. The AHC decision is reversed, and the case is remanded.



                                          ______________________________________
                                          Richard B. Teitelman, Judge

All concur.




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