By Mary Alexander and Timothy Gustafson

The Arizona Court of Appeals held that a liquidation exception to the functional test for business income does not exist in Arizona and that a taxpayer’s sale of its wholly owned subsidiary was business income. The parties to the sale made an I.R.C. § 338(h)(10) election, which required the taxpayer to treat the sale of the subsidiary’s stock as an asset sale. Arizona statutes and regulations adopt a functional test for business income whereby gain from property qualifies as business income if the property was used in the taxpayer’s trade or business. The court held that a liquidation exception was inconsistent with the functional test because it focused on the “nature of the transaction” instead of on the “relationship between the property and the taxpayer’s business.” The frequency of a transaction was considered irrelevant in determining the relationship of the property to the business. As the taxpayer had previously treated the income that resulted from the subsidiary’s assets as “arising in the regular course of business,” the sale of the subsidiary’s stock constituted business income as well. First Data Corp. v. Ariz. Dep’t of Rev., Dkt. No. 1 CA-TX 11-0008 (Ariz. Ct. App. Nov. 26, 2013).