Appeal from judgment of Court of Common Pleas of Dauphin County, No. 369 Commonwealth Docket, 1960, in case of Commonwealth of Pennsylvania v. Scott Paper Company.
Thomas V. Lefevre, with him Samuel C. Harry, William M. Goldstein, and Morgan, Lewis & Bockius, for appellant.
Edward T. Baker, Deputy Attorney General, with him Edward Friedman, Attorney General, for Commonwealth, appellee.
Bell, C. J., Musmanno, Jones, Cohen, Eagen, O'Brien and Roberts, JJ. Opinion by Mr. Justice Cohen. Concurring and Dissenting Opinion by Mr. Justice Roberts. Mr. Chief Justice Bell and Mr. Justice Eagen join in this concurring and dissenting opinion.
This is an appeal by Scott Paper Company (Scott) in connection with its Pennsylvania corporate net income tax for the calendar year 1955. During that year Scott, a major producer of paper products, cut various quantities of timber owned by it and located in states outside of Pennsylvania. This cut timber had a fair market value on January 1, 1955, of $5,128,136; and all of it had been held by Scott for more than six months prior to January 1, 1955. Of this cut timber Scott used in its own business a quantity valued at $3,272,923. The remaining timber, valued at $1,855,213, was sold by Scott to other persons for a total price of $3,390,022.
Under specific provisions of the Federal Internal Revenue Code, Scott realized a capital gain of $4,414,021 on the cutting of this timber.*fn1 Section 631(a) of the Code gives to a taxpayer an election to consider timber cut by it during the year either for sale to others or for use in its own business as a "sale or exchange" of such timber. Section 1231(a) of the Code states that if gains on sales or exchanges of property used in a taxpayer's trade or business exceed the losses from such sales or exchanges during the year, these gains and losses shall be considered long-term in nature. Finally, § 1231(b) (2) rounds out this trail of artificial tax concepts by stating that the phrase "property used in the [taxpayer's] trade or business" in § 1231(a) shall include timber covered by § 631. By this labyrinthine route a cutting of timber for use in one's own business may be transformed into a longterm capital gain subject to the attendant tax benefits
applicable to such form of income for federal tax purposes. Internal Revenue Code of 1954, § 1201.
In its 1955 federal income tax report Scott made the election allowed by § 631(a) and showed the above gain as "net long-term capital gain" and so included it in federal taxable income. In its Pennsylvania corporate net income tax report it allocated all of this gain outside of Pennsylvania in accordance with the provision of § 2 of the Corporate Net Income Tax Act which states that gains realized from the sale or exchange of tangible capital assets situated outside of Pennsylvania shall be allocated entirely outside of Pennsylvania.
In settling Scott's tax, however, the state refused to allocate this amount in accordance with the above provision. Instead, it treated the $4,414,021 as ordinary income subject to the regular three-fraction allocation formula, thereby diverting part of this income (and the tax thereon) to Pennsylvania.
Scott appealed,*fn2 and the court below divided the income into two categories. As to the gain arising from the cutting by Scott of timber for use in its own business, the court disallowed the specific allocation outside of Pennsylvania, presumably on the ground that there was no sale or exchange. As to the remaining gain -- that arising from the cutting of timber later sold to others -- the court held there was a sale or exchange of a tangible capital asset and allowed the outside allocation. In reaching each of these conclusions, however, the lower court rejected Scott's argument that the characterization of the transaction for federal tax purposes controlled the state treatment. Instead, it held that the matter was one solely governed by state law, being a problem of allocation rather than one of
computation of taxable income. Only the latter, it said, was controlled by federal concepts.
Scott appealed to this Court from the adverse ruling on the timber used by it in its business. No appeal has been taken by the Commonwealth with respect to the lower court's allowance of ...