Can a state tax a part of the capital gain realized by a non-domiciliary corporation on the sale of stock of a subsidiary? That was the issue in a case entitled MeadWestvaco Corp. v. Illinois Department of Revenue US_(2008). The Supreme Court concluded that the decision of the Appellate Court, permitting such taxation, was premised upon an incorrect principle and remanded the case to the lower court for further proceedings consistent with the High Court’s ruling.
It seems certain that, on remand, the appeals court will find in favor of the taxpayer in light of the fact that the Supreme Court has eviscerated the basis on which the lower court assessed the tax in the first instance.
In 1968, Mead, an Ohio corporation, paid $6 million to acquire the stock of Data Corp., which owned an inkjet printing technology and a full-text, information-retrieval system. The latter operation, based in Illinois, flourished and became Lexis/Nexis.
In 1994, Mead sold Lexis/Nexis for some $1.5 billion and realized over $1 billion in capital gains. For Illinois taxation purposes, Mead contended that the capital gain qualified as “non-business income” that should be allocated in its entirety to Mead’s domiciliary state, Ohio. By contrast, the state of Illinois said that the capital gain constituted “business income” subject to apportionment by Illinois.
The facts revealed that Lexis/Nexis was subject to Mead’s oversight, but Mead did not manage its day-to-day affairs. Mead was headquartered in Ohio while a separate management team ran Lexis/Nexis out of the latter’s headquarters in Illinois. The businesses maintained separate manufacturing, sales, and distribution facilities, as well as separate accounting, legal, human resources, credit and collections, purchasing, and marketing departments.
Mead’s involvement with Lexis/Nexis was generally limited to approving Lexis/Nexis’s annual business plan and any “significant corporate transactions.” In fact, Lexis/Nexis purchased most of its paper from suppliers other than Mead and, in general, neither entity was a “significant customer” of the other.
On these facts, the trial court in Illinois concluded that Lexis/Nexis and Mead did not constitute a “unitary” business. Nonetheless, Illinois could tax an “apportioned share” of Mead’s capital gain because “Lexis/Nexis served an operational purpose in Mead’s business.”
The appellate court affirmed the trial court’s decision. It said that Lexis/Nexis served an “operational function” in Mead’s business. As a result, an apportioned part of Mead’s capital gain could be subjected to Illinois taxation because: Lexis/Nexis was wholly-owned by Mead; Mead had exercised control over Lexis/Nexis in various ways and Mead had consistently described itself as engaged in “electronic publishing”.
The Supreme Court, in an opinion authored by Justice Alito, noted that where, as here, there is no dispute that the taxpayer has done some business in the taxing state, the inquiry shifts from whether to what (the state may tax). To answer this question, the Supreme Court has developed the so-called “unitary-business principle.” Under that principle, a state may tax an apportioned sum of the corporation’s multi-state business, but only if the business is found to be unitary.