In a tax case appeal settled on Tuesday, Maine’s highest court unanimously ruled against Gannett Co. — and in favor of the pine tree state — regarding how much the media giant should pay in income taxes with respect to a gain it reaped from selling off its cable division eight years ago. At issue was whether Gannett’s subsidiaries comprised a “unitary” business, which would give the state the right to tax the company on a portion of the sell-off. The case may have wider appeal, so it is worth examining the arguments and subsequent court opinion.
In 1995 Gannett purchased the stock of Multimedia Inc. and immediately sold off Multimedia’s entertainment and security alarm businesses. But Gannett chose to keep the newly acquired cable television systems that operated in Kansas, Oklahoma, and North Carolina. Then on January 31, 2000, Gannett sold the cable division to Cox Communications for $2.75 billion, realizing a taxable gain of $2.54 billion. (The gain was substantial because the basis of the cable division was not “stepped up” and Gannett inherited Multimedia’s low, historical basis in the division.1)
Gannett distributes a few of its national newspapers in Maine, and in 1998, it bought the NBC-affiliated television stations in Portland and Bangor. As a result, Gannett’s Maine tax returns for 1999 and 2000 depicted the corporation as a “unitary” business that included the cable division. Consequently, Gannett’s 2000 tax return included the $2.54 billion gain from the sale of the cable division.
Later, arguing that the cable division was not part of its unitary business, Gannett made a claim for refund, and the lower court, Maine Superior Court, found for Gannett. However, in Gannett Co., Inc. v. Maine State Tax Assessor (Me. No. Ken-07-629, Nov. 18, 2008), the Maine Supreme Court reversed the lower court’s decision.
By law, a state may tax an activity only to which it has a “definite link or connection.” A state, therefore, may not tax value earned outside of its borders. Maine uses the “unitary business/formula apportionment approach” — as do most states — to identify “in-state value.”
Under this approach, if activities inside and outside the state constitute one single integrated business enterprise, it is fair to include the income from out-of-state activities in apportionable income. (See Container Corp. v. Franchise Tax Board, 463 US 159 (1983).) A unitary business is defined as a company that engages in activities characterized by four criteria: unity of ownership, functional integration, centralization of management, and economies of scale.
In this case, the court found that the cable division formed part of a single business enterprise with Gannett’s newspaper and broadcast television operations. Accordingly, the production of income by the cable division (in Kansas and elsewhere) was integrated with Gannett’s newspaper and broadcast television operations in Maine. In short, Gannett’s operations were integrated.
The court found that Gannett’s activities were functionally integrated in various ways. For example, Gannett provided centralized tax, legal, audit, financial, and risk-management services to all of its affiliates, which were billed for these services “at cost.” Moreover, the court found that the intercompany services Gannett provided to its business units — services that an independent business would ordinarily perform for itself — was a form of centralized management.
Further, by providing the centralized services, Gannett created economies of scale. And by supplying centralized health and benefit plans, Gannett also provided evidence of a unitary business.
What’s more, Gannett shared the expertise of its management with all of its affiliates, including the cable division. Having interlocking directors and officers is also evidence of a unitary business, and here, three of the cable division’s officers also held the same position for all of Gannett’s affiliates.
Lastly, Gannett maintained a “common pool of cash” from which any of its affiliates could draw, on an interest-free basis, to pay for capital expenses or for their operating systems. Such a cash-management system creates economies of scale, as well as functional integration. In fact, the use of such a cash-management system, which allows subsidiaries to readily access interest-free funds, results in a “flow of value” — the essential prerequisite of a unitary business.
At the end of the day, since the cable division was found to be part of Gannett’s unitary business activities, the gain from the sale of that division was included in the “base” of income that Maine could properly tax. Therefore, the portion of the gain properly apportioned to Maine was legitimately taxed by the state.
Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com. This extra column was written in response to this week’s Gannett court decision.
1There was no step-up because Gannett had purchased the stock of Multimedia and did not make, with respect to the purchase, an election under Section 338 of the Internal Revenue Code.